Moving Averages

Moving averages are primarily used to smooth out the short term price fluctuations, or noise, and to provide an indication of the overall trend of the price. Moving averages are also considered as dynamic trendlines. Generally, the longer the period is used to construct the moving averages, the less sensitive it is to the latest price changes. Simple and exponentially weighted moving averages are the most widely used averages although there can be many variations as to how moving averages can be constructed.

Typically, when a price moves below its moving average, say 50-day simple moving average, it is a bearish signal while when a price crosses above it moving average it is a bullish signal.

Trading signals can also be generated by using a combination of multiple moving averages, such as a 20-day and a 50-day moving average. When the faster 20-day moving average crosses above the slower 50-day moving, it is a bullish signal, while when the faster moving average crosses below the slower moving average, it is a bearish signal. It should be noted that moving averages, due to the way they are constructed, are lagging indicators and as with any other tools, it is susceptible to generate false signals as well.