Stock trading is a way to profit from price movements. To analyze price movements and the opportunities they present, traders use technical indicators. The moving average is one of the most reliable and popular technical indicators. It is the average of all closing prices for the specified period. Averaging out smoothens the price information and reduces the noise from daily price fluctuations.
There are short-term moving averages such as the 10-day or 7-day averages, and long-term moving averages such as 200-day averages. For example, a 200-day moving average is the average closing price of the 200 most recent trading days. These are useful in indicating price trends as well as providing a trend line for placing potential support or resistance.
Moving averages eliminate the volatility of stock prices every day from the stock chart. It looks like a trendline on the price chart. This gives traders a quick view of the trend.
Directions of prices
Prices will likely rise if the moving average is in an upward trend, while prices may be rising if there is a strong uptrend. Prices are likely to be falling if it's a downtrend. However, a steep downward slope could indicate that prices have reached their bottom.
A trend line that moves sideways is indicative of a price movement within a certain range. If real-time prices rise above the MA (moving average), this signals an uptrend. However, if prices fall below the MA, prices will tend to move in the opposite direction. As you will see, two moving averages with different durations can merge and cross in opposite directions.
As reliable and trustworthy support and resistance levels, medium- to long-term moving averages such as the 200-day and 50-day ones are very popular. These levels are difficult to break. This makes it more useful as a signal to sell or buy a stock when the price reaches the resistance and support levels. Trending markets have prices that move within a certain range. Prices tend to bounce off the support level of moving averages, or pull back from touching the resistance level. Again, these levels can only be breached if enough buyers or sellers come in. This allows for a reasonable holding time.
BSE Sensex's 50-day moving mean (purple), crosses its 200-day moving median (yellow).
One of the most popular trading strategies is to use both short-term moving averages such as 50 days and longer-term ones such as 200 days to determine the stock's bullishness.
As you can see from the BSE Sensex price chart above, a stock's 50 day MA is considered a Golden Cross if it surpasses a 200-day MA. This is a sign of a bullish shift in sentiment. You will also see the shares touching support levels on long-term moving averages, which indicates that prices have reached their bottom.
The lag effect of moving averages has been criticized often. They show a trend that is based on historical prices. They are not useful for distilling daily price movements. However, they provide a reliable and strong level of support and resistance. It is helpful for traders to understand how to use moving averages to buy stocks and take short positions.