Five Quick Facts about Moving Averages

Nov 4, 2007: 11:14 AM CST

Many traders use different forms of analysis for moving averages, and understanding basic facts about moving averages can add new potential for profit in your own trading.

While there are ‘hard and fast’ rules to using moving averages, the best results often come from novel or unique interpretations of basic concepts, or variations on ‘old’ themes.

Here are five quick facts about moving averages:

1. The longer the average, the fewer times price will retrace to it, but the more significant the test

Price will ‘test’ (touch) the 200 period average far fewer times than it will a 20 period average, but the touching (testing) of the 200 is in terms of a signal is more important than the 20 period.

2. The longer the average, the greater the significance of a price penetration

All things being equal, a violation (price falling through in an uptrend, or rising above in a downtrend) of a 200 period moving average carries much more significance than that of a 20 period. More traders and investors are watching the longer term averages, and hedge/mutual funds sometimes make major decisions regarding price behavior at longer period moving averages, which essentially ‘creates’ price movement due to violations.

3. Signals on Higher Time Frames are more significant than those of Lower Time Frames

While moving average analysis and rules are valid on very short time frames, MA Crossovers, price penetrations, price inflections, and other signals on larger time frames (daily/weekly) will lead to larger price moves and carry more significance than lower time frame signals (5-minute, 15-minute).

4. Moving Average Structure reveals clues to Underlying Trends

Studying the orientation of three or more moving averages leads to confirmation of trend identification. In addition to higher highs/higher lows, one can demand that the 10 period moving average be above the 20 period, and the 20 be above the 50 period, and the 50 be above the 200 period (or some other combination) before taking a long position, so that you can be assured that you are taking a position in line with a strong trend. A strong trend will exhibit a cascade effect of moving averages, and some traders study this cascade through analysis of the “Moving Average Ribbon”.

5. Exponential Moving Averages Work Better for Closer Moving Averages

While there are a variety of moving averages (weighted, displaced, triangular, simple, exponential), most traders report that signals are more accurate when using an exponential moving average for time periods less than 50 periods, and a simple moving average for periods greater than 50 periods. There are traders who base major decisions just on the 20 period exponential moving average. Because exponential moving averages put more emphasis on the most recent data, traders find shorter period moving averages (10, 20, 30, 40) capture price movement in terms of retracements better than simple moving averages.

These are quick summaries of deeper concepts, but study and observe for yourself in your own analysis and trading to try to develop a better understanding of the best ways that work for you to interpret moving averages to yield more consistent results.

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One Response to “Five Quick Facts about Moving Averages”

  1. Forex Trading Support » Blog Archive » Moving Averages and Trading For a Living Says:

    […] Five Quick Facts About Moving Averages – according to this article, longer moving averages are more significant than short and exponential moving averages are better for shorter time frames […]