Moving Average Part 1

Introduction

The Moving Average (MA) is one of the most common technical indicator used on price charts. The MA is simply calculating the average price of a data in a specific time frame. There are different ways /methods to calculate the average. A simple moving average is calculated using the “normal” average calculation. For example, to calculate the 3-day simple moving average, add up the prices for the last 3 days and divide it by three. That should give you the simple moving average. There are other types of moving average such as the Weighted Moving Average, Exponential Mowing Average, etc.

Simple Moving Average

A 3-day simple moving average (SMA) on a daily price chart simply means the average price for the last 3 days, including today. The moving average is normally calculated on the closing price. Some use the moving average on the other price data such as High, Low, Open, Typical Price, Median Price and so on. It is called moving because price changes against time.

For example, yesterday’s 3-day moving average may be different from today’s moving average. Yesterday’s moving average does not take into account today’s price in its calculation. There are many reasons why we use the moving average but average is commonly used to reduce some noise in price fluctuations.

Uses of Moving Average

1. Trend Direction

One of the most important analysis on price chart is to identify the trend. The moving average is used because it reduces the noise in price fluctuations. Price can go up and down aggressively and therefore difficult to identify the price trend.

There are different trends, as describe by Dow Theory and we need to know which trend we are trying to identify. There are short, medium and long term trends. We need to use the correct parameter (time frame used to calculate the moving average) to identify the different trends.

A short term trend is normally identified using parameter less than 30 days. A medium term trend is identified using a moving average between 30 to 60 days while long term trends are identified using a moving average above 60 days.

However, different instruments have different price trend characteristics and it is up to us to determine the moving average parameter used in a particular instrument.













From the charts above;

Identifying Up trend:
i) When price is above and stays above the moving average for some time
ii) When the moving average is increasing.

Identifying Down trend
i) When price is below and stays below the moving average for some time
ii) When the moving average is declining

Identifying Sideway trend
i) When price cuts the moving average frequently in a short period of time
ii) When the moving average is at the same level for some time

Two or more moving averages are normally used in a chart to identify short to long term trend directions.


KL Composite Index chart with 30 and 60 day simple moving average

* Charts are created from NextVIEW Advisor.

Click HERE for PART 2: Uses of Moving Averages