Moving Averages a Trend Following Indicator

BY Chris Andreou

|October 8, 2020

There are many questions traders need to answer before placing a trade. After all, the aim of chart construction is to assist the trader with answering the question – will markets rise or fall at some future point in time?

The Moving Average

The moving average is essentially a trend following device which serves the purpose of providing a signal that a new trend has begun or that an old trend has ended or reversed. The moving average is a tool that helps answer the above question.

The moving average does not predict market action as price does, the moving average is a follower, not a leader.

  • Price is a leading indicator
  • Moving Averages are lagging indicators or follower of price

What is a moving average?

A moving average is a method of calculating the average value of a financial assets price over a period.

  • The term “moving” implies that the average changes or moves.
  • As the assets price changes over time, its average price moves up or down.

The moving average never anticipates; it only reacts!

Using moving averages as part of your trading system

The most popular method of interpreting a moving average is to compare the relationship between a moving average of an assets closing price and the assets closing price itself.

  • Sell signal: When prices fall below the moving average.
  • Buy signal: When prices rise above the moving average.

This type of moving average trading system is not intended to get you in at the exact bottom and out at the exact top.

It is designed to keep you in line with the assets price trend by buying shortly after the assets price bottoms and selling shortly after price has topped.

What is the best Moving Average?

The length of a moving average should fit the market time frame you wish to follow:

Trend Moving Average Length

Trend Moving Average Length
Very short term: 5-13 days
Short term: 14-25 days
Minor Intermediate: 26-49 days
Intermediate: 50 – 100 days
Long term: 100-200 days

Now that you have a better understanding of moving averages try and experiment using short, medium- and longer-term moving averages on your charts and see what you can discover!

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