Popular, reliable and simple trend indicators for price charts are moving averages. These are the closing prices for a certain number of consecutive trading day. Based on the needs of investors, the averages may be short-, medium-, or long-term.
The short-term moving averages are more affected by daily price fluctuations, but the long-term averages are smoother and show a clear direction for price movements. These trends can only be used to indicate historical prices.
A short-term trend indicator is the 7-day moving average (MA). It simply represents the average closing price of the seven most recent trading days. It is the trend line on the price chart that shows how the average closing prices have changed over the past week.
The 7-day trend line for BSE Sensex stock prices is shown in purple. It is a reflection of the steep downward trend of prices due to certain global triggers such as the Coronavirus pandemic and spiralling economy. Also, it reflects large-scale dumping of stocks by buyers in an effort to exit the investment before more losses.
Add the closing prices for stock for a specified number of days (day 1+day 2+day 3...day N) and divide the sum by n to get the moving mean for that duration.
Let's take stock ABC as an example. The closing prices of the stock for the seven most recent trading days are shown below.
|Day||Closing price (Cp).|
7-Day moving average=(Cp1+Cp2+Cp3+Cp4+Cp5+Cp6+Cp7)/7=416.
The 7-day moving average will sum up the seven most recent prices to calculate the average price for day 1. To calculate the moving average for day 2, we will subtract the first data point and multiply the value for each of the remaining 8 days. This allows the market to move in sync with the moving average.
Moving averages are often criticized for having a lag effect, especially if they use prices from the past. A short-term average of the market direction shows how the markets have reacted to price movements. However, traders can still use moving averages to see if there are any future trends or if prices have peaked. It can help traders to see potential trade opportunities and determine when they should exit or enter them. The price movements are more responsive to short-term moving averages.
The moving averages can be used to double as support or resistance levels in the short term. These levels can be used by traders to decide when they should enter or exit a trade. Prices usually touch the points at which support and resistance are located before retreating.
Another popular trading strategy is to use the moving average to determine when to sell or buy. This strategy allows traders to buy when prices rise above the moving average, and sell when they fall below it. The rise and fall in trading volumes is also an important consideration for traders. If the price rises with an increase of volume, it is indicative that there is demand and it is a better decision to buy.
Moving averages are, at their most basic, trend indicators. They can be very useful in trending market. This indicator quickly indicates whether stock prices are in an upward or downward trend. It may indicate a peak in prices if it is steep. A steep downtrend may indicate a bottoming out of prices.
To identify a potential uptrend or decline in the near future, traders use several moving averages with varying durations. If the short-term moving average is higher than the long-term, traders can expect an identical upward trend in prices. If the short-term MA moves below the long-term MA, this could indicate a downtrend.