A moving average is one of the most versatile and widely used of all of the technical indicators. Because of the way it is created it is easily quantified and tested. A moving average is used with many mechanical trend based systems.
When we try and read charts we are interpreting something that is subjective. A triangle or pendant maybe seen by one trader but another will see nothing. This is why a moving average works. It gives definite trading signals.
How is a moving average created? The market represents its prices in bars and a moving average is made up of the closing prices of a set number of bars. The different numbers of bars in the moving average creates different sensitivity in the indicator. To create a moving average we add up a all of the closing prices of the previous bars. We then divide this total by the number of bars in our moving average.
If we had a 50 bar moving average the computer would add up the closing prices for the previous 50 bars. To get the moving average the total is then divided by 50. A moving average changes over time as new closing prices are added to the calculation and the oldest closing prices are removed. On our price charts this is displayed as 1 continuous line.
A moving average is used to identify the direction of the trend and the number of bars in a moving average determines the sensitivity of the moving average. A 10 bar moving average will change direction (trend) quicker than a 50 bar moving average.
Once we are aware of this sensitivity we need to know how this affects our trading. A moving average with a low number of bars is very sensitive and can give lots of false trading signals. The advantage however is that we are entering trends very early and when we do get a trend our profit potential is increased.
To counter the false trading signals we can use a moving average with a larger number of bars. This gives us more positive signals but on the downside we enter the trend a later point and this reduces profit from the trend.
The moving average produces trading signals when we combine it on a chart with market prices. When the market is rising we are looking for the market to move above our moving average and then close a bar. Once this has happened we have a buy signal.
The opposite is true with a downward trend. When the market crosses below the moving average and then the bar closes a sell signal has been produced. Some traders also prefer to wait for conformation of the tend. They will also wait until the moving average to starts to move in the direction of the new trend before opening a trade.
When we try and read charts we are interpreting something that is subjective. A triangle or pendant maybe seen by one trader but another will see nothing. This is why a moving average works. It gives definite trading signals.
How is a moving average created? The market represents its prices in bars and a moving average is made up of the closing prices of a set number of bars. The different numbers of bars in the moving average creates different sensitivity in the indicator. To create a moving average we add up a all of the closing prices of the previous bars. We then divide this total by the number of bars in our moving average.
If we had a 50 bar moving average the computer would add up the closing prices for the previous 50 bars. To get the moving average the total is then divided by 50. A moving average changes over time as new closing prices are added to the calculation and the oldest closing prices are removed. On our price charts this is displayed as 1 continuous line.
A moving average is used to identify the direction of the trend and the number of bars in a moving average determines the sensitivity of the moving average. A 10 bar moving average will change direction (trend) quicker than a 50 bar moving average.
Once we are aware of this sensitivity we need to know how this affects our trading. A moving average with a low number of bars is very sensitive and can give lots of false trading signals. The advantage however is that we are entering trends very early and when we do get a trend our profit potential is increased.
To counter the false trading signals we can use a moving average with a larger number of bars. This gives us more positive signals but on the downside we enter the trend a later point and this reduces profit from the trend.
The moving average produces trading signals when we combine it on a chart with market prices. When the market is rising we are looking for the market to move above our moving average and then close a bar. Once this has happened we have a buy signal.
The opposite is true with a downward trend. When the market crosses below the moving average and then the bar closes a sell signal has been produced. Some traders also prefer to wait for conformation of the tend. They will also wait until the moving average to starts to move in the direction of the new trend before opening a trade.
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