Saturday, July 2, 2011

Technical Analysis - Moving Averages

Follow Me on Facebook Follow Me on Tweeter

What is the most important indicator in technical analysis? Some of the traders may name you a row of various indicators which they learned from the bottom to the top and which they consider as the most useful and the most important in making a trading decision. The reality is that the most important indicator is the simplest one. The indicator without which technical analysis would not exist at all. The correct answer on the question about the most important indicator is - Moving Average.

Moving average is the basic and the simplest indicator in technical analysis. I would recommend to any beginner in technical analysis to start from moving average. Moving average is simply average value over specified period of time (price bars). There are a number of various moving averages, starting from the SMA (Simple Moving Average), EMA (Exponential Moving Average) and by finishing various complicated Weighted Moving averages. This technical indicator could be analyzed by itself but it also used as a component in most of the other indicators.

There are several thing that on the first view could be seen obvious, yet, that every trader should always remember about moving averages:

1. Moving averages are used to smooth movement fluctuation. It could be applied to price, volume, advance/decline data or any other data and technical indicator to smooth choppy movements and to see general direction of the movement of price, volume or any other indicator.

2. While moving average smoothes movement it brings factor of a delay (also known as a lag). The more you smothe the bigger lag is and the further in the time the moving average is shifted from the real movements.

When you go deeper in technical analysis there always will be a conflict. From one side you want to avoid choppy trading (frequent signals) which usually generates number of fake signals and from other side you want to keep the lag (delay in trading signals) as small as possible and to avoid late entering and exiting a trade. From one side you will have desire to increase bar period setting of a moving average or any other technical indicator to have more smooth trading and from other side you will be willing to have signals as close to the tops and bottoms as possible.

The truth is it is not as easy as it looks like. There is no golden rule what bar period setting should be used with moving averages or any other technical indicators. Before, selecting a setting for an indicator (in our case moving average) that would generate signals, a trader should learn how to recognize different market conditions. Because in different markets different setting would be recommended.

No comments: