Moving Averages are one of the most popular and often-used technical indicators. The moving average is easy to calculate and, once plotted on a chart, is a powerful visual trend-spotting tool. You will often hear about three types of moving averages: simple, exponential and linear. The best place to start is by understanding the most basic: the simple moving average (SMA). Let's take a look at this indicator and how it can help traders follow trends toward greater profits.
There can be no complete understanding of moving averages without an understanding of trends. A trend is simply a price that is continuing to move in a certain direction. There are only three real trends that a security can follow:
An uptrend, or bullish trend, means that the price is moving higher.
A downtrend, or bearish trend, means the price is moving lower.
A sideways trend, where the price is moving sideways.
There are various kinds of moving averages. Of these, the most commonly quoted is the daily moving average. If you want to track the trend over, say, a period of 30 days, you monitor the 30-DMA. This will help you identify the short term bullish or bearish outlook by comparing the current trading price to the average.
However, in situations such as these, volatility is high. So one day markets may fall 400 points, and rise 300 points the very next day. To counter these drastic fluctuations, analysts use the 200-DMA or the 200 day moving average. Since this average takes into account values over a longer term of 200 days, it eliminates short-term instabilities.
So, if the value of a stock is falling, traders wait for it to reach a certain level called 'support' before buying. Similarly, if the price of a stock is rising, then it is better to wait until it reaches the higher point of a range called the 'resistance' level.
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