Moving Averages

Simple Moving Average

The Simple Moving Average is arguably the most popular technical analysis tool used by traders. The Simple
Moving Average (SMA) is often used to identify trend direction, but can be used to generate potential buy
and sell signals. The SMA is an average, or in statistical speak - the mean. An example of a Simple Moving
Average is presented below:

The prices for the last 5 days were 25, 28, 26, 24, 25. The average would be (25+28+26+26+27)/5 = 26.4.
Therefore, the SMA line below the last days price of 27 would be 26.4. In this case, since prices are
generally moving higher, the SMA line of 26.4 could be acting as support (see: Support & Resistance).

The chart below of the Dow Jones Industrial Average exchange traded fund (DIA) shows a 20-day Simple Moving
Average acting as support for prices.

Moving Average Acting as Support - Potential Buy Signal

When price is in an uptrend and subsequently, the moving average is in an uptrend, and the moving average has
been tested by price and price has bounced off the moving average a few times (i.e. the moving average is
serving as a support line), then a trader might buy on the next pullbacks back to the Simple Moving Average.

A Simple Moving Average can serve as a line of resistance as the chart of the DIA shows:
Moving Average Acting as Resistance - Potential Sell Signal

At times when price is in a downtrend and the moving average is in a downtrend as well, and price tests the SMA
above and is rejected a few consecutive times (i.e. the moving average is serving as a resistance line), then a
trader might sell on the next rally up to the Simple Moving Average.

The examples above have been only using one Simple Moving Average; however, traders often use two or even
three Simple Moving Averages. The potential advantages to using more than one Simple Moving Average is
discussed on the next page.

Moving Average Crossovers

Moving average crossovers are a common way traders can use Moving Averages. A crossover occurs when a faster
Moving Average (i.e. a shorter period Moving Average) crosses either above a slower Moving Average (i.e. a longer
period Moving Average) which is considered a bullish crossover or below which is considered a bearish
crossover.

The chart below of the S&P Depository Receipts Exchange Traded Fund (SPY) shows the 50-day Simple Moving
Average and the 200-day Simple Moving Average; this Moving Average pair is often looked at by big financial
institutions as a long range indicator of market direction:
Note how the long-term 200-day Simple Moving Average is in an uptrend; this often is interpreted as a signal that
the market is quite strong. A trader might consider buying when the shorter-term 50-day SMA crosses above the
200-day SMA and contrastly, a trader might consider selling when the 50-day SMA crosses below the 200-day
SMA.

In the chart above of the S&P 500, both potential buy signals would have been extremely profitable, but the one
potential sell signal would have caused a small loss. Keep in mind, that the 50-day, 200-day Simple Moving
Average crossover is a very long-term strategy.

For those traders that want more confirmation when they use Moving Average crossovers, the 3 Simple Moving
Average crossover technique might be used. An example of this is shown in the chart below of Wal-Mart (WMT)
stock:

The 3 Simple Moving Average method could be interpreted as follows:

1. The first crossover of the quickest SMA (in the example above, the 10-day SMA) across the next quickest
SMA (20-day SMA) acts as a warning that prices might be reversing trend; however, usually a trader
would not place an actual buy or sell order then.
 2. Thereafter, the second crossover of the quickest SMA (10-day) and the slowest SMA (50-day), might
trigger a trader to buy or sell.

There are numerous variants and methodologies for using the 3 Simple Moving Average crossover method, some
are provided below:

A more conservative approach might be to wait until the middle SMA (20-day) crosses over the slower
SMA (50-day); but this is basically a two SMA crossover technique, not a three SMA technique.

A trader might consider a money management technique of buying a half size when the quick SMA crosses
over the next quickest SMA and then enter the other half when the quick SMA crosses over the slower
SMA.

Instead of halves, buy or sell one-third of a position when the quick SMA crosses over the next quickest
SMA, another third when the quick SMA crosses over the slow SMA, and the last third when the second
quickest SMA crosses over the slow SMA.

A Moving Average crossover technique that uses 8+ Moving Averages (exponential) is the Moving Average
Exponential Ribbon Indicator (see: Exponential Ribbon).

Moving Average crossovers are often viewed tools by traders. In fact crossovers are often included in the most
popular technical indicators including the Moving Average Convergence Divergence (MACD) indicator
(see: MACD).

Exponential Moving Average (EMA)

The Exponential Moving Average (EMA) weighs current prices more heavily than past prices. This gives the
Exponential Moving Average the advantage of being quicker to respond to price fluctuations than a Simple
Moving Average; however, that can also be viewed as a disadvantage because the EMA is more prone to
whipsaws (i.e. false signals).

The chart below of eBay (EBAY) stock shows the difference between a 10-day Exponential Moving Average (EMA)
and the 10-day regular Simple Moving Average (SMA):

The main thing to notice is how much quicker the EMA responds to price reversals; whereas the SMA lags during
periods of reversal.

The chart below of the Nasdaq 100 exchange traded fund (QQQQ) shows the difference between moving average
crossovers (see: Moving Average Crossovers) possible buy and sell signals with a EMA and a SMA:
As the chart above of the QQQQ's illustrates, even though EMA's are quicker to respond to price movement,
EMA's are not necessarily faster to give possible buy and sell signals when using moving average crossovers.

Also note that the concept illustrated in the chart above with Exponential Moving Average crossovers is the
concept behind the popular Moving Average Convergence Divergence (MACD) indicator; (see: MACD).

Since Exponential Moving Averages weigh current prices more heavily than past prices, the EMA is viewed by
many traders as superior to the Simple Moving Average; however, every trader should weigh the pros and the cons
of the EMA and decide in which manner they will be using moving averages.

Nevertheless, Moving Averages remain the most popular technical analysis indicator out on the market today.

Weighted Moving Average

The Weighted Moving Average places more importance on recent price moves; therefore, the Weighted Moving
Average reacts more quickly to price changes than the regular Simple Moving Average (see: Simple Moving
Average). A basic example (3-period) of how the Weighted Moving Average is calculated is presented below:

Prices for the past 3 days have been $5, $4, and $8.

Since there are 3 periods, the most recent day ($8) gets a weight of 3, the second recent day ($4) receives a
weight of 2, and the last day of the 3-periods ($5) receives a weight of just one.

The calculation is as follows: [(3 x $8) + (2 x $4) + (1 x $5)] / 6 = $6.17

The Weighted Moving Average value of 6.17 compares to the Simple Moving Average calculation of 5.67. Note how
the large price increase of 8 that occured on the most recent day was better reflected in the Weighted Moving
Average calculation.

The chart below of Wal-Mart stock illustrates the visual difference between a 10-day Weighted Moving Average
and a 10-day Simple Moving Average:
Potential buy and sell signals for the Weighted Moving Average indicator are discussed in depth with the Simple
Moving Average indicator (see: Simple Moving Average).

Adaptive Moving Average

Adaptive Moving Averages changes its sensitivity to price fluctuations. The Adaptive Moving Average becomes
more sensitive during periods when price is moving in a certain direction and becomes less
sensitive to price movement when price is volatile.

The chart below of the E-mini Nasdaq 100 Futures contract shows the difference between an Exponential Moving
Average (see: Exponential Moving Average) which weights current prices more heavily than past prices and the
Adaptive Moving Average which changes sensitivity based on price volatility:

The advantage of the Adaptive Moving Average is show above in the e-mini chart in the center where price became
directionless and choppy. During that period the Adaptive Moving Average maintained a straight line appearance;
whereas, the Exponential Moving Average moved with the choppiness of prices. However, when price trended, like
on the far right of the e-mini chart above, the Adaptive Moving Average kept up with the Exponential Moving
Average.

The Adaptive Moving Average is definitely an unique technical indicator that is worth further investigation.

Typical Price Moving Average

The Typical Price Moving Average combines the Pivot Point concept and the Simple Moving Average. The Pivot
Point (see: Pivot Points) calculation is shown below:

Pivot Point = (High + Low + Close) / 3

The calculated Pivot Point number is then inputed into the regular Simple Moving Average (see: Simple Moving
Average) equation; rather than the input of the closing price, the Pivot Point calculation is used.

The chart below of the mini-Dow Jones Industrial Average Futures contract shows the slight difference between a
10-day Simple Moving Average and a 10-day Typical Price Moving Average:

The Typical Price attempts to give a more real representation of where price has been by incorporating the high
and low price into the most often used closing price. The Typical Price is consequently seen as a more pure Simple
Moving Average; nevertheless, as can be referenced by the chart above of the mini-Dow Future, there is not much
difference between either Moving Average.

Potential buy and sell signals for the Typical Price Moving Average indicator are discussed on the Simple Moving
Average indicator pages (see: Simple Moving Average).

Triangular Moving Average

The Triangular Moving Average is a Simple Moving Average that has been averaged again (i.e. averaging
the average); this creates an extra smooth Moving Average line.

The chart below of the E-mini Nasdaq 100 Futures contract shows the relation between a 10-day Simple Moving
Average and a 10-day Triangular Moving Average:
Generally, simple moving averages are smooth, but the re-averaging makes the Triangular Moving Average even
smoother and more wavelike.

Potential buy and sell signals for the Triangular Moving Average indicator are discussed on the Simple Moving
Average indicator pages (see: Simple Moving Average).