Академический Документы
Профессиональный Документы
Культура Документы
Techno-Funda Society
Techno-Funda Society or lovingly called TFS, is aimed at bringing together people
who love stocks and psychology. First things rst, this is NOT an advisory service
giving buy/sell calls. There are enough on TV already. This is purely a learning
platform. Think of it as a school on stock market. The range of topics discussed
would be wide covering basic market introduction, books, charting techniques,
psychology, emotional control, trading strategies and so on. Hope you'd enjoy your
stay !!!
Moving averages are one of the most basic tools that a warrior of technical
analysis must have in his arsenal.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 1/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Wait !!! I said, "most basic", but don't get misled. They are one of the most
powerful tools out there. Simple things must be mastered well if one wants
to master the subject.
Just think of it; addition, subtraction, division and multiplication are the
most simple concepts in mathematics but they are the most powerful ones
and everything is built upon them.
Similarly, a lot of other tools in TA, like Bollinger Bands, MACD and several
others, are built upon moving averages.
In technical analysis, there are only three original primary data items
namely 'Price', 'Volume' & 'Open Interest (in case of Futures &
Options)'. Everything else is just a derivative of either one of them or a
combination of them.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 2/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
You must have also heard the term, 'Oscillators'. Oscillators are just a type
of indicators whose value oscillate between 0 and 100. Some examples are
Stochastics, Relative Strength Index (RSI) and so on
So, if you need to take an average weight of Rahul (70 Kg), Sunil (65 Kg),
Ajay (68 Kg), Rohit (74 Kg) and Ram (80 Kg), this is how we'd do it.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 3/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Remember, this is a stock market tutorial and not a math's class and stock
prices are always moving. So, when we go out to take average of stock
prices, they keep moving. A new price data keeps getting added to the
calculation while an old price data keeps getting removed from the
calculation. Confusing? no problem, I'll cover it later.
Since stock prices are always moving, they appear to be random and
meaningless and thus a system is needed which smooths out the noise and
randomness from the price and presents a clean picture. Moving averages
do just that thing. They smooth out the noise from the prices and confirm
the price trend.
There are several types of moving averages but only two of them are most
usable, practical and popular. The two most common types of moving
averages are, "Simple Moving Average (SMA)" and "Exponential
Moving Average (EMA)".
Here, I have taken closing price data of 20 sessions (from 17th August 2017
to 14th September 2017) of Ashok Leyland Limited and calculated 3-Period
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 4/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Points to Note
1.) Let's take the example of 3-Day SMA calculated above. See how the
average is moving. For the first 2 days, no SMA is calculated. The first value
of a 3-Day SMA appears on the close of third day and same with 5-Day and
10-Day SMAs.
2.) To calculate first value of a 3-Day SMA, the average of Day 1, Day 2 and
Day 3 is taken. Then, to calculate second value of 3-Day SMA, Day-1 is
removed from the calculation and Day-4 is added. So, the second value of a
3-Day SMA constitute Day 2, Day-3 and Day-4. Similarly, to calculate the
third value of 3-Day SMA, Day-3, Day-4 and Day-5 are taken. This is why it
is called a moving average. With every next value, a past period disappears
from the calculation and a future period gets added to the calculation.
3.) You can calculate SMA over any time period. In the example above, I
have calculated 3,5 and 10-Period SMA. You can also take 20-Period, 50-
Period, 100-period SMA or of any other period that you may like.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 5/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Period, 100-period SMA or of any other period that you may like.
4.) Another thing to note is that since the primary price data that I have
taken is daily closing prices, so a 10-Period SMA means a 10-Day SMA and
so on. You can use price data of any time-frame. So, for example, if you use
weekly closing prices as primary data, then a 10-Period SMA will mean a 10-
Week SMA. If you use closing prices of every 1 Hour to calculate the SMA
then a 10-Period SMA will mean 10-Hour SMA. If you use closing prices of
every 10 minutes to calculate the SMA then a 10-Period SMA will mean 10-
(10 Minute) SMA or a 100-Minute SMA. Interesting, isn't it?
5.) Also observe that the 3-Day SMA value and 5-Day SMA value are closer
to the price than the 10-Day SMA is the farthest. This is because a 10-Day
SMA value includes data of past 10 days hence it does not reflect the current
price as closely as a 3-day or 5-Day SMA do.
Time to see the real action now. Let's put on the chart (Chart-1) of
Ashok Leyland Limited to see the whole thing clearly.
See how the 3-Day SMA is the most responsive to price change. 5-day SMA
is also moderately responsive to price change and 10-Day SMA is the least
responsive to price change.
Due to this property of moving averages, while comparing two SMAs, the
one with smaller period is called FAST SMA and the one with longer
period is called SLOW SMA. So, while comparing a 3-Day SMA and a 5-
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 6/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
period is called SLOW SMA. So, while comparing a 3-Day SMA and a 5-
Day SMA, former is Fast SMA and latter is Slow SMA. While comparing 5-
Day SMA and 10-Day SMA, former is Fast SMA and latter is Slow SMA.
But don't worry. Robin Sharma says, "All change is hard at first,
messy in the middle but gorgeous in the end". So, let's move onto
EMA now.
EMA reduces the lag a little bit but as I said, lag is inherent in all moving
averages. But comparatively, EMA has lesser lag than SMA. Other than
resolving lag issue a bit, EMA also solves another problem. See, while
calculating SMA, all price points are given equal weight. What I
mean is that if you calculate a 20-Day SMA, the price of the security 20 days
before is given as much importance (weight) as today's price. This is not
right practically. You'd agree that yesterday's price is definitely more
important than price 50 days old price. I am sure you all remember the post
on "Why Stock Prices Move"? If not, then you can read it by clicking
here. And people tend to remember near term prices much more than old
prices. So, future prices are more affected by prices of recent past. But, how
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 7/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
prices. So, future prices are more affected by prices of recent past. But, how
does EMA solve this issue? EMA solves this issue by giving more weight to
recent prices while calculating the average. Due to this, EMA
calculation is a bit more complex than SMA.
You don't really have to calculate either SMA or EMA manually. So, if you
are not interested in getting into it, you can skip this calculation part and go
straight to the next part of the post.
As I said that you don't have to calculate these things as all the charting
platforms create SMAs and EMAs at the click of a button. Of course that's
wonderful. But there is a dark side to it as well. And that is that it makes you
lazy. In earlier times, when there were no charting software, people used to
calculate indicators manually and plot them manually on the paper. That
gave them a feel of indicators and price action. So, I am not suggesting that
you should get back to plotting indicators and overlays by hand but knowing
the logic of calculation will surely help you in forming trading strategies.
Step-1
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 8/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Step-1
Step-2
So, if you want to calculate 3-Period EMA, the weight-multiplier will be:
Step-3
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 9/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Points to Note
All the 5 points which applied to SMA (1 to 5) are equally applicable to EMA
as well.
Now, having understood both SMA and EMA, there must be two questions
that must be brewing in your mind, yes exactly two.
Question 1
Question 2
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 11/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
This is just like asking, "which car is the best car?". You see, there is no
answer to this question. It all depends upon your requirements. If your
requirement is sheer speed, Ferrari will fit the bill. If your requirement is
safety, Audi can be the car that you're looking for and if your requirement is
luxury, Bentley might satisfy you. See, there is just no on answer.
Similarly, there are several ways to approach the decision of choice between
SMA & EMA and Fast moving average & Slow moving average.
SMA Vs EMA
As you all observed above that the only difference between an SMA and
EMA is that SMA gives equal weight to all the prices while EMA gives more
weight to recent prices by applying a weight-multiple. So, it is evident that
EMA will respond to price action more effectively that SMA. In other words,
an EMA is slightly Faster than SMA. Remember I told above that a short
period moving average is faster than a long period moving average. But,
periods being equal, EMA is faster than SMA.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 12/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
So, you can clearly observe that SMA has more Lag than EMA. So, which
one to use? The answer is that you must experiment with both of them and
see which one fits the price structure in a better way. Both have their own
benefits and limitations.
While SMA is true average of the prices and thus acts as better support and
resistance but it gives late signals. EMA gives timely signals but it tends to
give false signals as well due to more sensitivity. So, the only way to find the
perfect one is to experiment.
There is no formula here too. But yes, let me tell you few general practices.
The most famous time periods are 10-Period, 20-Period, 50-Period, 100-
Period and 200-Period. Short term traders swear by 5 to 20-Period moving
averages. Medium term trend-followers are most interest in 20 to 50-Period
moving averages while long term traders or investors use 100 to 200-Period
moving averages. Some traders use a 9-Period EMA while other use a 10-
Period SMA. It all depends upon their style of trading, time-frame and the
suitability on that specific price chart.
There are several trading strategies based on moving average but the most
popular strategies can be classified into 2 categories, Price Crossover and
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 13/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Moving Average Crossover. Let's take them one on one, one by one (no
pun).
Price Crossover
The most simplest moving average strategy is to buy when price crosses
above the average and sell/short when price crosses below the moving
average. When price moves above the moving average, it is called a bullish
crossover and when price falls below the moving average, it is called a
bearish crossover.
Let's understand it from the point of view of a short-term swing trader. I'd
simulate multiple situations using different Period EMAs and see how
signals are generated. Let's assume that a buy signal is generated every time
price crosses above the moving average and sell/short signal is generated
every time price crosses below the moving average. Also, note that cross will
be valid only if price closes above or below the moving average. Reliance
Industries Limited is taken as an example.
One can infer a lot of things from this chart. One, that the number of
whipsaws (false signals) drastically reduced and the length of valid signals
also increased. In other words, a 20-Period EMA allowed us to stay with the
trend longer than a 10-Period EMA.
You can see that it allowed us to stay in the trend a lot longer than both 10-
Period and 20-Period EMAs while shortening the whipsaws.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 15/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Can you see how the number of buy/sell signals reduced from 10 in case of a
10-Period EMA to just 2 signals?
The more you'd increase the length of look-back period, the less the number
of signals will be generated and less whipsaws will be there.
But, then what's to think about it? Let's just use a 100-Period or better a
200-Period moving average and ride the trend.
It's not that simple. See, while an investor or a cash-trader (those who take
delivery of shares) will prosper using a 100-Period or 200-Period moving
average, a futures trader will get bankrupt. The reason is that while a 100-
Period moving average won't even change its course on a 3-5% fluctuation
in price, a trader's risk capacity might only be 0.5% to 1%. So, price will fall
a lot before the long term moving average will generate a signal thus
exposing the trader to the vagaries of the market. The other problem is that
it will generate signals less often thus giving a trader less opportunity to
make money.
So, it's a fight between sensitivity and reliability. While a short period
moving average will be highly sensitive, it won't be reliable and while a long
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 16/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
moving average will be highly sensitive, it won't be reliable and while a long
period moving average will be reliable, it will take a lot of price movement
for it to move thus creating very less opportunities for a trader.
So, if price is above long period moving average, only long trades taken. And
a short trade will only be taken if price is below long period moving average.
However the trade will be taken only when price moves above or below
short period moving average.
Let's say we take a set of two averages, 20-Period EMA and 100-Period
EMA. First will be our timing tool and second will be our direction tool. And
this is how it will work:
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 17/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Now, compare it with Case-2 (Chart-5). As you can see, in case-2, a total of 6
signals were generated. 3 signals were valid and 3 were whipsaws. In this
case, a total of 7 signals were generated. 3 signals were valid, 3 were in no
trade zone and only 1 was a whipsaw.
In this strategy, moving average is not seen with relationship to price but
with other moving average. So, 2 moving averages are taken, one short
period and one long period. A long signal is generated when short period
average crosses above the long period moving average and a sell/short
signal is generated when short period average crosses below the long period
average. When a short period moving average crosses above a long period
average, it is called Golden Cross. And, when a short period moving
average crosses below a long period average, it is called Death Cross. Any
combination of short-long averages can be taken but the terms Golden
Cross and Death Cross are used mostly in reference to 50-200 average
combination.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 18/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
Since we are not concerned with price crossing above or below any moving
average and only with moving averages crossing each other, only 2 signals
were generated. One signal got whipsawed and the other allowed us to ride
the trend. Notice that so many times price fell below 20-Period EMA, at
times price even fell below 50-Period EMA but since 20-Period EMA did
not cross 50-Period EMA, no action was warranted. Any, combination can
be chosen depending upon time-frame of the trader and suitability on
specific price chart. So, one must play around with multiple sets of moving
averages to see which set suits the price structure best. Some traders use a
triple moving average crossover strategy, wherein they only buy
when the shortest period average crosses above both the middle period and
the long period average and they sell/short only when the short period
average crosses below both the middle and the long period moving average.
A very popular combination for triple crossover, among medium term
traders, is 10-20-50 Period average.
So, slope and distance must also be taken into consideration before taking
any decision.
The only reason that traders experiment with so many strategies is that they
want to keep whipsaws as minimum as possible and want to elongate the
trend riding period to as maximum as possible.
1. Signal Generation
I guess, I have covered this whole topic in the strategy section that how
moving averages generate buy/sell signals.
2. Support/Resistance
Prices tend to find support and resistance in their moving averages. Again,
different period moving averages act as support/resistance in different
terms. Also remember, a support moving average once broken turns into a
resistance and vice versa.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 20/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
As you can see that in Chart-10, a 50-Period EMA is overlaid on daily chart.
Observe, how beautifully price took support at 50-Period EMA on every
retracement (correction). These supports could have given perfect
opportunities to go long on several occasions. The point is that it's not about
50-Period EMA. It's about finding the perfect fit for a specific price action.
Thus, I am repeatedly saying that play around and have fun with moving
averages. After all, all you have to do is to click and not calculate.
1. As I said that moving averages are lagging overlays, thus they are prone to
whipsaws. Since moving average is a trending indicator, it will give
wonderful signals while price is trending but it will generate a lot of
whipsaws while price is moving sideways. One can judge the trend of the
price by the slant (slope) of moving average. While a short term trend would
be reflected in the slant of of a 10-20 period average, a long term trend
might reflect well in the slant of 100-200 period average. Remember, a
small price fluctuation will change the course of a 20-Period EMA but it will
take a lot of price fluctuation to move a 200-Period EMA. This must be
always remembered.
2. One size does not fit all. So, play around with different period moving
averages and different strategies for every stock. Some price actions fit well
with a 20-Period moving average while some fit well with a 50-Period
moving average. The key is to find the best fit. Also, note that all the
examples in the post are given on daily chart. However, while playing with
different period moving averages, a good trader also experiments with the
time frame of the chart itself. So, while a 20-Period EMA might perfectly
suit the daily chart, on weekly chart, some other period might fit well. It's all
about spending time with charts and moving averages.
4. Another strategy to avoid whipsaws is to create a time and price filter. For
example, while using a simple price crossover strategy, don't just go long
when price crosses above a selected time period moving average. Rather, set
a filter in terms of time or price. A time filter can be that a bullish price
crossover will only be valid if price stays above the moving average for 2
days or 3 days. As price filter can be that a bullish price crossover will only
be valid if price penetrates the moving average by at least 1% or 3%.
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 22/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
5. Finally, as with any other tool of technical analysis, moving averages are
subjective and are best used in combination with other tools for best results.
Let me end the post with the quote of legendary trader, Marty Schwartz.
REPLY
REPLY
REPLY
REPLY
REPLY
REPLY
This post is exclusively for those who are interested in learning VALUE
INVESTING but are clueless about where to start and what to do. In fact,
I always have a new set of people asking me this question almost
READ MORE
READ MORE
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 25/26
9/20/2017 Moving Averages- A Comprehensive Guide !!!
READ MORE
READ MORE
Powered by Blogger
NISHANT ARORA
Follow 37
VISIT PROFILE
Archive
Report Abuse
http://www.technofundasociety.com/2017/09/moving-averages-comprehensive-guide.html 26/26