A:

Moving averages are very popular tools used by technical traders to measure momentum. The main purpose of these averages is to smooth price data so traders can be in a better position to gauge the likelihood that a current trend will continue. Moving averages are commonly used to predict areas of support and resistance and are also used in conjunction with other indicators to help give more accurate entry/exit signals. There are different types of averages that vary in popularity but, regardless of how they are calculated, they are all interpreted in the same manner.

A crossover is a popular trading signal that occurs when the price of an asset crosses through a moving average, or two moving averages cross over each other. This type of signal is regarded as an early indication of the direction of future momentum. For example, traders wishing to enter into a long position will buy an asset when the price crosses above a moving average and sell the asset when it crosses below. As you can see from the chart below, upward momentum increases when a short-term average crosses above a long-term average.

macross_1r.gif

Moving averages are often used to predict areas of support and resistance. As you can see from the diagram above, the price of an asset often finds support at major averages such as the 50/200 daily moving averages. Traders use these averages to help them to choose strategic areas to set price targets or stop-loss orders. Many traders exit their positions once the price of the assets falls bellow major moving averages because it suggests that downward momentum is likely to increase.

The smoothing characteristics of moving averages are often applied to other technical indicators to help reduce the chance of getting a false transaction signal. A short-term average is often applied to indicators such as the stochastic oscillator, moving average convergence divergence (MACD), price rate of change (ROC) and on-balance volume (OBV) to generate transaction signals. This average is known as a trigger line and transactions are made when the indicator crosses through this average. In general, long positions are taken when the indicator crosses up through the trigger line and short positions are taken when it crosses down.

For further reading, see the Moving Averages Tutorial.

RELATED FAQS
  1. What are the most common periods used in creating Moving Average (MA) lines?

    Learn the most commonly selected periods used by traders and market analysts in creating moving averages to overlay as technical ... Read Answer >>
  2. What technical tools can I use to measure momentum?

    One of the main goals of every trader using technical analysis is to measure the strength of an asset's momentum and the ... Read Answer >>
  3. What are the main advantages of using Moving Averages (MA)?

    See why moving averages have proven to be advantageous for traders and analysts and useful when applied to price charts and ... Read Answer >>
  4. How can I use simple moving averages to signal when to buy or sell stocks?

    Learn about simple moving averages, simple moving average strategies and how to use these strategies to signal buy and sell ... Read Answer >>
  5. What does it mean when an index or stock exhibits a death cross?

    Find out what it means when an index, stock or exchange exhibits a death cross pattern between its short-term and long-term ... Read Answer >>
  6. Why is the Moving Average (MA) important for traders and analysts?

    See why the statistical concept of moving averages plays a central role for traders and chartists who rely on technical analysis ... Read Answer >>
Related Articles
  1. Investing

    How To Use A Moving Average To Buy Stocks

    The Moving Average indicator is one of the most useful tools for trading and analyzing financial markets.
  2. ETFs & Mutual Funds

    Using Moving Averages to Buy ETFs

    Learn how to use moving averages to enter and exit trades in ETFs, and understand some popular technical setups using moving averages.
  3. Trading

    Simple Moving Averages Make Trends Stand Out

    The moving average is easy to calculate and, once plotted on a chart, is a powerful visual trend-spotting tool.
  4. Trading

    Use Moving Averages to Buy Stocks

    A moving average constantly updates a stock's average price, but it cannot predict a stock's performance.
  5. Trading

    A Primer On The MACD

    Learn to trade in the direction of short-term momentum.
  6. Trading

    The Four Most Common Indicators in Trend Trading

    Here are the top indicators and tools trend traders use to establish when trends exist and find entry/exit points.
  7. Trading

    The 7 Pitfalls Of Moving Averages

    While moving averages can be a valuable tool, they are not without risk. Discover the pitalls and how to avoid them.
  8. Managing Wealth

    Using Technical Indicators To Develop Trading Strategies

    Unfortunately, there is no perfect investment strategy that will guarantee success, but you can find the indicators and strategies that will work best for your position.
  9. Markets

    What's a Death Cross?

    A death cross is seen when the short-term moving average of a security or index falls below its long-term moving average.
  10. Trading

    Do Adaptive Moving Averages Lead To Better Results?

    These complex indicators can help traders interpret trend changes, but are they too good to be true?
RELATED TERMS
  1. Signal Line

    A moving average plotted alongside a technical indicator and ...
  2. Simple Moving Average - SMA

    A simple, or arithmetic, moving average that is calculated by ...
  3. Golden Cross

    A crossover involving a security's short-term moving average ...
  4. Moving Average Ribbon

    A technique used in technical analysis to identify changing trends. ...
  5. Death Cross

    A crossover resulting from a security's long-term moving average ...
  6. Confirmation

    The use of an additional indicator or indicators to substantiate ...
Hot Definitions
  1. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  2. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  3. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  4. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  5. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  6. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
Trading Center