InvestorQ : What exactly are moving averages and how important are these moving averages in taking a view on the direction and strength of the stock?
Bhavik Nehru made post

What exactly are moving averages and how important are these moving averages in taking a view on the direction and strength of the stock?

Niraj Mehta answered.
2 years ago

As a trader in the market, you must be familiar with commonly used phrases like DMA, EMA etc. While DMA refers to the Daily moving averages, the EMA refers to the Exponential moving average. The EMA is a more sophisticated mathematical method of calculating the moving averages although more often the DMA analyzes over different time frames are useful enough. Some of the most popular periodicity of moving averages includes 50 DMA, 100 DMA and 200 DMA. Just like candlesticks, these moving averages are also an addition technical method to ratify your trading view on the stock or the index overall. That is why, in addition to studying candlestick formations, technical traders can draw from a virtually endless supply of technical indicators of which moving averages are one of the most important.

Irrespective of whether you are a rookie trader or a professional high end trader, the moving averages are something you simply cannot do without. Moving averages are probably the single most widely-used technical indicator. How do you actually apply moving averages to your trading decision? Many trading strategies utilize one or more moving averages. A simple moving average trading strategy can be something like, “Buy as long as price remains above the 50-day exponential moving average (EMA) but sell the stock as long as price remains below the 50 EMA”. Again, you are free to decide whether you want to use the 50-day, 100-day or the 200-day moving average based on your outlook and time frame for the trade.

One of the important application of moving averages is to identify crossovers. What is a crossover? Normally, a buy signal is generated when a lower order EMA line crosses over the higher order EMA trend line. For example, the crossover trading strategy might be to buy when the 50-period moving average crosses above the 100-period moving average or when the 100-day EMA crosses above the 200-Day EMA. It shows that the shorter trend is becoming positive within a longer trend and that is a good way to initiate a long trade. The opposite approach can also be used to identify selling points in the trade.

The higher a moving average number is, the more significant price movement in relation to it is considered. For example, price crossing above or below a 100- or 200-period moving average is usually considered much more significant than price moving above or below a 5-period moving average. As we started earlier, the moving average is a statistical tool to smoothen the price fluctuations. Hence a very short period moving average will have a chart that is similar to the simple price chart. The bare minimum should be 50-DMA as that is when the first visible trends can be seen and used for interpretation or for actual trading.