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.
To calculate a 200 bar moving average we add up (in reality our computer does this for us) the closing prices of the previous 200 bars. We then take this total and divide it by the number of bars (200 in this case). As the market is always adding new bars these are added into the moving average and the oldest bars are removed. We always maintain 200 bars for our calculation.
We use a moving average to help us identify a trend. Because the sensitivity of the moving average is dictated by the number of bars. A 20 bar moving average changes direction quicker than a 100 bar moving average.
The length of moving average we use is subjective and dictates the frequency of trading signals we receive. When we use a small number moving average we will get lots of false trading signals. However when a trend does develop we will be joining the trade in it's early stages.
When we use a moving average with a larger amount of bars we reduce the number of false signals. However we sacrifice some potential profit from the trend. Therefore the length of the moving average we use depends on our trading style.
How does the moving average produce trading signals? Say we have a 25 bar moving average and the market is rising. We are waiting for the market to rise and cross our moving average line. As soon as a bar closes higher than our moving average we have a buy signal.
When the market is falling we are looking for it to move below our moving average. When this happens we wait until the bar closes and we have our sell signal. We can use the moving average to act as a conformation signal. To do this we must wait until the moving average has turned to match our new trend. When we are looking to make a buy we wait until the moving average turns up on our chart. Therefore confirming our trend. The same is true for a down-trend but in reverse.
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.
To calculate a 200 bar moving average we add up (in reality our computer does this for us) the closing prices of the previous 200 bars. We then take this total and divide it by the number of bars (200 in this case). As the market is always adding new bars these are added into the moving average and the oldest bars are removed. We always maintain 200 bars for our calculation.
We use a moving average to help us identify a trend. Because the sensitivity of the moving average is dictated by the number of bars. A 20 bar moving average changes direction quicker than a 100 bar moving average.
The length of moving average we use is subjective and dictates the frequency of trading signals we receive. When we use a small number moving average we will get lots of false trading signals. However when a trend does develop we will be joining the trade in it's early stages.
When we use a moving average with a larger amount of bars we reduce the number of false signals. However we sacrifice some potential profit from the trend. Therefore the length of the moving average we use depends on our trading style.
How does the moving average produce trading signals? Say we have a 25 bar moving average and the market is rising. We are waiting for the market to rise and cross our moving average line. As soon as a bar closes higher than our moving average we have a buy signal.
When the market is falling we are looking for it to move below our moving average. When this happens we wait until the bar closes and we have our sell signal. We can use the moving average to act as a conformation signal. To do this we must wait until the moving average has turned to match our new trend. When we are looking to make a buy we wait until the moving average turns up on our chart. Therefore confirming our trend. The same is true for a down-trend but in reverse.
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