Understanding Moving Averages (Part 1)

03/31/2008 12:00 am EST


Most literature written on technical analysis, more specifically technical indicators, begins with moving averages. The reason for this is simple; they are considered by most analysts the most basic and core trend-identifying indicators. As its name would suggest a moving average calculates an average of price range over a specified period. For example, a ten-day moving average gathers the closing prices of each day within the ten-day period, adds the ten prices together and then of course divides by ten. The term moving implies that as a new day's closing price is added to the equation, the day that is now eleven-days back is dropped from the equation. Figure 1 shows an example of a simple moving average line placed on a candlestick chart.

The example above outlines what would be considered a simple moving average. There are at least seven varieties of moving averages, but generally the average trader is focused on just one of the following three:

- Simple moving averages
- Exponential moving averages
- Weighted moving averages

What are moving averages trying to tell us?

More in part 2 tomorrow.

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