How to enhance your trading strategy with a moving average?
A moving average is a statistical tool that enables you to make smarter and quicker decisions. It is an essential indicator as it is incisive, adaptive, and forms the basis for other trend analysis tools. It is a stock market analysis tool, widely used to determine what stocks to buy today (on a given date).
What is a moving average?
An average is a basic statistical tool that is representative of a set of numbers. A moving average is a time-driven average. It is named so because it changes or ‘moves’ in alignment with the movement of underlying data. Therefore, it is beneficial in understanding an ever-evolving data set, such as stock market trends or its level of support or resistance.
Computing a moving average
Step 1: Decide on period classification. You can choose a daily, weekly, monthly, or quarterly moving average. Typically, days or weeks are considered.
Step 2: Decide on a period. If you choose ‘days’ in step 1, you can select 7-Day or 14-Day moving averages. Steps 1 and 2 depend on your time horizon for investment.
Step 3: The most straightforward way is to add the stock prices for the selected number of days and divide the total by the number of days. The stock price to be considered for each day can be chosen between opening price, closing price, and median price.
Why should you use a moving average?
- To simplify data
Moving average eliminates or ‘smoothens out’ minor ups and downs, which may not be relevant to your purchase decision. This way, you can read the information that you need without the noise caused by temporary fluctuations.
- To provide relevancy
Since they pertain to an immediately preceding period on computation, they are naturally updated to encompass the latest stock prices. They can be more accurate representatives and predictors of stock market movements.
- To make data easy to compute
Calculating moving average is relatively simple, and anybody with a rudimentary grasp of mathematics or statistics can easily compute, comprehend and apply this concept for making stock market moves.
How are moving averages classified?
These are the three significant variations of moving averages:
- Simple Moving Average (SMA)
SMA is the arithmetic mean of stock prices for a specified period.
- Weighed Moving Average (WMA)
Weights are allotted to different days. The more relevant days (typically the ones closer to the date of computation) are given a higher weightage, and the weighted mean is computed to arrive at the WMA.
- Exponential Moving Average (EMA)
This is a variation of WMA, where a greater weightage is given to recent stock prices, and the remainder of the weightage is given to previous data points.
Navigating the stock market is an intellectual challenge. Understanding and applying the concept of moving average could significantly enhance the quality of your investments in the stock market today.
To refine your investment strategy, reach out to a financial expert today!
