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Moving Average (all methods)
Description
A moving average is a method of calculating the average value of a
security's price, or indicator, over a period of time. The term
"moving" implies, and rightly so, that the average changes or moves.
When calculating a moving average, a mathematical analysis of the
security's average value over a predetermined time period is made.
As the security's price changes over time, its average price moves
up or down.
MetaStock calculates and displays six different types of moving
averages: simple (also referred to as arithmetic), exponential, time
series, triangular, variable, and weighted. In addition, MetaStock
will calculate moving averages of the security's open, high,
low, close, median price, typical price, volume, open interest, or
indicator.
The only significant difference between the various types of moving
averages is the weight assigned to the most recent data. Once this
"weighting" scheme has been determined, it is held static over the
range of calculations. The exceptions are the variable moving
average and volume adjusted moving average. The variable moving
average automatically adjusts its weighting based on market
conditions. A variable moving average becomes more sensitive to
recent data as volatility increases and less sensitive to recent
data as volatility decreases. Similarly, the volume adjusted moving
average automatically adjusts as the security's volume increases and
decreases.
Moving Average Calculation Methods
Interpretation
The most popular method of interpreting a moving average is
to compare the relationship between a moving average of the
security's closing price and the security's closing price itself. A
sell signal is generated when the security's price falls below its
moving average and a buy signal is generated when the security's
price rises above its moving average.
This type of moving average trading system is not intended to get
you in at the exact bottom and out at the exact top. Rather, it is
designed to keep you in line with the security's price trend by
buying shortly after the security's price bottoms and selling
shortly after it tops.
The critical element in a moving average is the number of time
periods used in calculating the average. When using hindsight, you
can always find a moving average that would have been profitable.
The key is to find a moving average that will be consistently
profitable. The most popular moving average is the 39-week (or
200-day) moving average. This moving average has a good track record
in timing the major (long- term) market cycles. The length of a
moving average should fit the market cycle you wish to follow:
You can convert a daily moving average quantity into a weekly moving
average quantity by dividing the number of days by 5 (e.g., a
200-day moving average is almost identical to a 40-week moving
average). To convert a daily moving average quantity into a monthly
quantity, divide the number of days by 21 (e.g., a 200-day moving
average is very similar to a 9-month moving average).
MetaStock enables you to plot moving averages of securities and any
of the indicators tracked by the program. The interpretation of an
indicator's moving average is similar to the interpretation of a
security's moving average: when the indicator rises above its moving
average, it signifies a continued upward movement by the indicator;
when the indicator falls below its moving average, it signifies a
continued downward movement by the indicator.
Indicators which are especially well-suited for use with moving
average penetration systems include the
MACD,
Price R.O.C.,
Momentum, and
Stochastics.
Some indicators, such as short-term Stochastics, fluctuate so
erratically that it is difficult to tell what their trend really is.
By removing the indicator (i.e., setting the Indicator Style to
Invisible in the Indicator's Properties dialog) and then plotting a
moving average of the indicator, we can see the general trend of the
indicator rather than its day-to-day fluctuations.
Whipsaws can be reduced, at the expense of a slightly later signal,
by plotting a short-term moving average (e.g., 2-10 day) of
oscillating indicators such as the 12-day
R.O.C.,
Stochastics, or the
RSI. For example, rather
than selling when the Stochastic Oscillator falls below 80, you
might sell only when a 5-period moving average of the Stochastic
Oscillator falls below 80.
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