In finance, a moving average (MA) is a widely-used stock indicator in technical analysis. Its primary purpose is to smooth out price data by providing an average price that is continuously updated.
The moving average helps to reduce the effects of short-term price fluctuations, offering a clearer view of the stock's overall trend over a specified period. Simple moving averages (SMAs) calculate the average price by taking an arithmetic mean of prices over a given timeframe. In contrast, exponential moving averages (EMAs) assign more significance to recent prices, making them more responsive to recent price changes compared to older data.

Analysts use moving averages to assess support and resistance levels by analyzing the asset's price movements. A moving average provides insight into past price behavior, helping to gauge the security's recent trends.

This information is then used to predict the potential future direction of the asset's price. As a lagging indicator, a moving average follows behind the price action of the underlying asset, offering signals and indicating the direction of trends based on historical data.

Types of moving averages

Simple Moving Average (SMA):
The Simple Moving Average (SMA) is the most basic type of moving average and reacts to price movement a little bit slower than the EMA.

Exponential Moving Average (EMA):
For intraday trading, traders may prefer to use the Exponential Moving Average (EMA) as it lags less than the SMA and is more responsive to recent price action over shorter periods of time. It is also better suited to breakout trades.

Volume Weighted Moving Average (VWMA):
The Volume Weighted Moving Average (VWMA) combines a measurement of price movement as influenced by tick volume. This indicator places more importance on movements in price owing to spikes or steep drops in tick volume. In a volatile market the VWMA will be quicker to pick up changes in volume and move more closely to price than the SMA. What this means in practical terms is that the WWMA alerts a trader to a potential breakout sooner than the SMA.


 

Why do we need moving averages?

Moving averages are essential in financial analysis for several reasons:
 

1. Trend Identification: They help identify the underlying trend of an asset by smoothing out short-term price fluctuations and highlighting longer-term movements.
2. Noise Reduction: By averaging out price data over a period, moving averages reduce the impact of random, day-to-day price volatility, making it easier to see the overall direction of the market.
3. Support and Resistance Levels: Moving averages can act as dynamic support and resistance levels. Prices often bounce off moving averages, making them useful for determining potential buy or sell points.
4. Signal Generation: Moving averages are used to generate trading signals. For instance, crossovers between short-term and long-term moving averages can signal potential buy or sell opportunities.
5. Trend Confirmation: They provide confirmation of trends by showing whether a stock is in an uptrend or downtrend. For example, if the price is above a moving average, it may indicate an uptrend, while being below it could signal a downtrend.
6. Market Timing: Investors use moving averages to time their trades more effectively, helping them make informed decisions based on the smoothed price trends rather than reacting to short-term market noise.
    

How to use moving averages?

All three moving averages come with settings for a range of time periods. Typical settings for moving averages:
●Long-term trend: 200 days (200 being roughly the number of trading days in a year)
●Medium-term trend: 50 days (50 being roughly 2 months of trading)
●Short-term trend: 9, 10 and 20 days
Traders typically use 2 or more time periods when planning a strategy.
Short-term traders and high-frequency traders will tend to use even shorter time periods, such as 4 and 6 hours, as they are trading very low time-frames, often as low as one minute.

To add a moving average to your chart, click on the ‘indicators’ option at the top of your chart and choose from the moving average types: Simple Moving Average (SMA), Exponential Moving Average (EMA), or Volume Weighted Moving Average (VWMA).

For instance, if you want to add EMAs with settings of 9, 50, and 200, select ‘Exponential Moving Average’ from the list and click three times. This will add three EMA lines to your chart. Since the default time period for each EMA will be the same, you should adjust the periods for two of them to 50 and 200 to match your desired settings.
 

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. 

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.