Friday, 13 January 2017

Moving Averages Analysis

The article describes using moving average in technical analysis to predict possible future stock trend direction as well as discusses several technical indicators based on the moving averages.

 Moving Averages Analysis

Moving average is one of the basic and most popular indicators in technical analysis. From the name of this indicator you may already understand that this indicator shows the average price of a security (stock, option, bond, etc) over specified period of time or specified period of bars. There are two most used types of moving average: Simple Moving Average (short name SMA) and Exponential Moving Average (short name EMA). The difference between simple and exponential moving averages is that exponential one uses weighing factors to reduce the lag in simple MA. 

The purpose of moving average is to smooth shorter-term price fluctuation within the longer-term trend in order to define the direction of the current longer-term trend. This technical indicator is one of the oldest in technical analysis and is considered as trend following indicator or a lagging indicator. Price moving averages themselves do not predict coming trend reversals but rather follow the changes in the trend. However, smoothing factor they use allows to filter small price changes and alert when the price-trend change has become critical to consider opening/closing a position.

Moving Averages are widely used in different trading systems to confirm trend as well as generate conservative longer-term trading signals. Over the last several decades technicians have build the number of other technical indicators based on the moving averages which help traders to define price volatility (example could be Standard Deviation indicator), recognize trend direction (as an example - MACD), as a signal line (for instance TRIX with Signal Line) and to smooth other technical indicators such as volume, advances and declines.

MACD and MACD Histogram are one of the most popular technical indicators calculations of which are based on the Moving Averages. In technical analysis MACD is considered as momentum indicator and is used to show the relation between fast (smaller bar period) and slow (bigger bar period) moving averages. This is a simple technical indicator that calculates the difference between two exponential moving averages by oscillating around zero line (center line). 

PPO (Percentage Price Oscillator) is another technical indicator that is very similar to MACD. Percentage Price Oscillator is calculated as ration between two moving averages (between fast and slow). It is analyzed and used in the same way MACD is used with the difference that it oscillates around 1 while MACD moves around 0.

Both MACD and PPO reveal the direction of the shorter term trend (fast MA) in relation to the longer term trend (slow MA) and used to generate trading signals from divergence, moving average crossovers and centerline crossovers.