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Moving
Averages (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
Pro 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
Pro 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
Pro 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. |
