Moving Averages: Factors To Consider
  1. Moving Averages: Introduction
  2. Moving Averages: What Are They?
  3. Moving Averages: How To Use Them
  4. Moving Averages: Factors To Consider
  5. Moving Averages: Strategies
  6. Moving Averages: Different Flavors
  7. Moving Averages: Conclusion

Moving Averages: Factors To Consider

By Casey Murphy, Senior Analyst

Data Used in Calculation
Most moving averages take the closing prices of a given asset and factor them into the calculation. We thought it would be important to note that this does not always need to be the case. It is possible to calculate a moving average by using the open, close, high, low or even the median. Even though there is little difference between these calculations when plotted on a chart, the slight difference could still impact your analysis.

Finding an Appropriate Time Periods
Because most MAs represent the average of all the applicable daily prices, it should be noted that the time frame does not always need to be in days. Moving averages can also be calculated using minutes, hours, weeks, months, quarters, years etc. Why would a day trader care about how a 50-day moving average will affect the price over the upcoming weeks? On the other hand, a day trader would want to pay attention to a 50-minute average to get an idea of the relative cost of the security compared to the past hour. Some traders may even use the average price over the past three minutes to gauge an uptake in short-term momentum.

No Average is Foolproof
As you know, nothing in the financial markets is for certain - certainly not when it comes to using technical indicators. If a stock bounced off the support of a major average every time it came close, we would all be rich. One of the major disadvantages of using moving averages is that they are relatively useless when an asset is trending sideways, compared to the times when a strong trend is present. As you can see in Figure 1, the price of an asset can pass through a moving average many times when the trend is moving sideways, making it difficult to decide how to trade. This chart is a good example of how the support and resistance characteristics of moving averages are not always present.

Figure 1

Responsiveness to Price Action
Traders who use moving averages in their trading will quickly admit that there is a battle between trying to make a moving average responsive to changes in trend while not allowing it to be so sensitive that it causes a trader to prematurely enter or exit a position. Short-term moving averages can be useful in identifying changing trends before a large move occurs, but the downside is that this technique can also lead to being whipsawed in and out of a position because these averages respond very quickly to changing prices. Because the quality of the transaction signals can vary drastically depending on the time periods used in the calculation, it is highly recommended to look at other technical indicators for confirmation of any move predicted by a moving average. (For more on various indicators, see Introduction To Technical Analysis.)

Beware of the Lag
Because moving averages are a lagging indicator, transaction signals will always occur after the price has moved enough in one direction to cause the moving average to respond. This lagging characteristic can often work against a trader and cause him or her to enter into a position at the least opportune time. For example, the only way for a short-term moving average to cross above a long-term moving average is for the price to have recently moved higher - many traders will use this bullish crossover as a buy signal. One major problem that often arises is that the price may have already experienced a large increase before the transaction signal is presented.As you can see in Figure 2, the large price gap creates a buy signal in late August, but this signal is too late because the price has already moved up by more than 25% over the past 12 days and is becoming exhausted. In this case, the lagging aspect of a moving average would work against the trader and likely result in a losing trade. Check out the next section of this tutorial to learn about trading strategies involving moving averages.

Figure 2

Moving Averages: Strategies

  1. Moving Averages: Introduction
  2. Moving Averages: What Are They?
  3. Moving Averages: How To Use Them
  4. Moving Averages: Factors To Consider
  5. Moving Averages: Strategies
  6. Moving Averages: Different Flavors
  7. Moving Averages: Conclusion
  1. Lagging Indicator

    1. A measurable economic factor that changes after the economy ...
  2. Death Cross

    A crossover resulting from a security's long-term moving average ...
  3. Linearly Weighted Moving Average

    A type of moving average that assigns a higher weighting to recent ...
  4. Average Price

    1. A representative measure of a range of prices that is calculated ...
  5. Average Return

    The simple mathematical average of a series of returns generated ...
  6. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following ...
  1. I keep hearing about the 50-day, 100-day and 200-day moving averages. What do they ...

    Whether you are using the 50-day, 100-day or 200-day moving average, the method of calculation and the manner in which the ... Read Answer >>
  2. What is a common strategy traders implement when using the Moving Average (MA)?

    Learn about a basic moving average strategy predicated on the relationship between a security's price action and its moving ... Read Answer >>
  3. Are exponential moving averages more effective than simple or weighted moving averages?

    Learn about different types of moving averages, as well as moving average crossovers, and understand how they are used in ... Read Answer >>
  4. 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 >>
  5. What is the difference between a simple moving average and an exponential moving ...

    The only difference between these two types of moving average is the sensitivity each one shows to changes in the data used ... Read Answer >>
  6. 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 >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center