Moving averages are pervasive in technical stock market analysis, because they are able to smooth price data, form trendlines and create an easily interpreted visual aid. Developed as a statistical tool for use in conjunction with data sets that span a specific period of time, moving averages have proven to be well-suited for price charts and other indicators.
Simple moving averages (SMAs) are calculated by the sum of data points in a time interval divided by the number of time periods therein. For example, a standard 10-day moving average on a candlestick price chart takes the value of each closing price, adds them together, then divides the resulting figure by 10. The length of the interval and data points chosen are left up to the individual trader, making moving averages highly pliable.
The exponential moving average (EMA) uses the same principles as the SMA, except it applies more weight to the most recent price bars. By emphasizing recent action, EMAs reduce lag in the time data and avoid distortions from information that may no longer be relevant.
Sometimes moving averages can help identify areas of support and resistance. In these circumstances, use simple rather than exponential or weighted moving averages.
The simplicity of moving average application and interpretation makes it possible to plot several different moving average lines at the same time, an advantage many other technical indicators lack. The relationship between shorter and longer moving average trendlines is the subject of much study, and traders look to crossovers for opportunities to buy, sell or short. Like any moving average signal, crossovers should be confirmed with another indicator. (For further reading, see: "Moving Average Strategies.")