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. How do technical analysts interpret the Average Directional Index (ADI)?

    The average directional index (ADX) is really a technical indicator of trendiness. Technical analysts believe that markets ... Read Full Answer >>
  2. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  3. How do you know where on the oscillator you should make a purchase or sale?

    Common oscillator readings to consider making a buy or sale are below 20 or above 80, respectively. More aggressive investors ... Read Full Answer >>
  4. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>
  5. How was the Fibonacci retracement developed for use in finance?

    The use of Fibonacci retracements in stock trading was popularized by noted technical analysts W.D. Gann and R.N. Elliott. ... Read Full Answer >>
  6. How reliable is the Fibonacci retracement in predicting stock behavior?

    The use of the Fibonacci retracement is subjective. There is no objective method to verify one application of the Fibonacci ... Read Full Answer >>
Related Articles
  1. Technical Indicators

    4 Ways to Find a Penny Stock Worth Millions

    Thinking of trading in risky penny stocks? Use this checklist to find bargains, not scams.
  2. Chart Advisor

    Stocks to Short...When the Dust Settles

    Four short trades to consider, but not quite yet. Let the dust settle and wait for a pullback to resistance for a higher probability trade.
  3. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  4. Chart Advisor

    Traders Step Back to Assess Commodities Damage

    Traders are turning to these exchange-traded notes and exchange-traded funds to analyze key commodities and determine what could be coming next.
  5. Trading Strategies

    Are You a Trend Trader or a Swing Trader?

    Swing traders and trend traders execute market timing strategies that require different skill sets.
  6. Technical Indicators

    Detrended Price Oscillator Trading Strategies

    The detrended price oscillator (DPO) offers a simple approach to cycle analysis, removing momentum and long-term trends from the equation.
  7. Investing

    Using Fibonacci to Analyze Gold

    Use Fibonacci studies to analyze gold by picking out hidden harmonic levels that can provide major support or resistance.
  8. Chart Advisor

    Real Estate Investment Trust ETFs Offer Stability

    Risk-averse traders are turning to real estate investment trusts. We'll look at a popular real estate investment trust ETF and few of its top holdings.
  9. Investing

    What Rising Volatility Means for Momentum

    After remaining torpid for most of the year, equity market volatility is once again rising.
  10. Chart Advisor

    Four ETFs for Trading Falling Crude Oil

    Commodity traders are turning toward oil because the recent move below a key support level is signaling a move lower. We'll look at four ETFs you can use to gain exposure.
RELATED TERMS
  1. Indicator

    Indicators are statistics used to measure current conditions ...
  2. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  3. Mass Index

    A form of technical analysis that looks at the range between ...
  4. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  5. On-Balance Volume (OBV)

    A momentum indicator that uses volume flow to predict changes ...
  6. Negative Volume Index - NVI

    A technical indicator that relies on changes in a security’s ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!