Moving Average

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admin
  • Moving average is a technical trend indicator used to gauge price direction of the stock or index.
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  • As the name implies, it averages the price of the stock or index and as the price data moves, average also moves.
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  • New daily price is included to calculate the average and old price data is removed one day at a time.
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  • Price average can be calculated over various time spans, common ones being 15,20,30,50,100,200 days.
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  • Longer the time span, less sensitive the average will be to price changes.
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How is moving average calculated?
 

  • There are 2 ways to calculate moving average-Simple Moving Average and Exponential Moving Average.
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  • However, in general while speaking of moving average, simple moving average is referred.
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  • Simple moving average is calculated by taking the average of the stock price over given period of time.
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  • For example 200 day moving average (DMA) is calculated by adding closing price of stock from last 200 days including current closing price and then dividing it by 200 (total number of time periods)
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Why moving average is used
 

  • The main purpose to use moving average is to identify the price trend of a stock or index as it helps to smoothen out the day to day price fluctuations.
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  • Generally, when the stock price is above the moving average upward trend is considered and when stock price is below the moving average the trend is considered downward.
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  • It is to be noted that moving average is a lagging indicator as it uses historical data and just shows the price trend.
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  • Other uses of moving average are it helps determine the support and resistance level of a stock price, setting stop losses.
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Crossover
 

  • Crossover is a common signal used in moving average to understand the shifts in price trends.
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  • Price crossover refers to when the stock price crosses through the moving average either above or below signaling change in trend.
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  • Charts below show nifty spot price and its 200 DMA from January 2000 to September 2014.
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Divergence from moving average
 

  • Divergence from moving average is calculated as the difference between stock prices from its moving average.
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  • Divergence signals trend reversals.
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  • When the divergence is high on either sides there is eminent trend reversal which can be observed in below chart.
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Divergence of Nifty Spot Price from 200 DMA

 

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