Basics Of Moving Averages
The concept of moving average is very easy to understand and to implement as well. It uses the stock prices (generally the daily close prices) for the past period. It uses the moving average of such prices for a specific period of time like 5, 10, 20, 50, 100, 150 or 200 days. The moving average can be calculated very easily in a spreadsheet by using a formula. The period of moving average is to be decided as per the needs of the analysis. Analysts normally take 100 DMA (100 day moving average) or 150 DMA or 200 DMA when the buy/sell signals are to be generated for long term investment. On the other hand, they normally take 10, 20 or 50 DMA when the buy/sell signals are to be generated for short term investment or for trading. In short, the period of DMA depends upon the investment horizon. Investors rely on the DMA for a longer period whereas the traders rely on the DMA for a shorter period. There is no hard and fast rule for a specific DMA to get the best or perfect results. One has to find out the correct DMA for a specific share or index by trial and error method. The method is actually used as mentioned below.
The DMA is calculated for the given historical data. Then a chart is plotted for the given period of time, stock prices and the DMA. The dates are shown along the X axis. The stock prices and the DMA are shown along the Y axis. The buy/sell signals are obtained as follows. A buy signal is generated when the stock price (or the index) line intersects the DMA line from below. It is also called as the breakout. On the contrary, a sell signal is generated when the stock price (or the index) line intersects the DMA line from above. It is also called as the breakdown. The longer period DMA generates less number of signals and the shorter period DMA generates a greater number of signals. Less number of signals can be relied upon to a greater extent. On the contrary, it is possible that a false signal is generated when a large number of signals are generated. The calculations of DMA for a short term and for a long term as well as the graphical representation of the data are explained in paragraphs to follow.
The basic concept used in this technique is the reversal of trend. The stock price (or the index) line slopes upwards to the right when the stock price or index is rising. As a result, the DMA line also slopes upwards to the right. At some point of time, the trend is reversed and the stock price (or the index) line starts sloping downwards to the right. However, the DMA line is still sloping upwards to the right. As a result, the stock price (or the index) line intersects the DMA line from above and generates a sell signal.
On the contrary, the stock price (or the index) line slopes downwards to the right when the stock price or index is falling. As a result, the DMA line also slopes downwards to the right. At some point of time, the trend is reversed and the stock price (or the index) line starts sloping upwards to the right. However, the DMA line is still sloping downwards to the right. As a result, the stock price (or the index) line intersects the DMA line from below and generates a buy signal.
Many reversals of trend are witnessed when the DMA for a short term is used and a very few reversals of trend are witnessed when the DMA for a longer term is used. It is possible to get a false alarm or signal when there are many signals. However, the probability to get a false signal is very low when limited signals are generated.
The DMA may be a simple DMA or an exponential DMA. The exponential DMA gives better results than the simple DMA. However, it does not mean that the simple DMA is not useful. Many people use the simple DMA in their analysis.
The concept of moving average is very easy to understand and to implement as well. It uses the stock prices (generally the daily close prices) for the past period. It uses the moving average of such prices for a specific period of time like 5, 10, 20, 50, 100, 150 or 200 days. The moving average can be calculated very easily in a spreadsheet by using a formula. The period of moving average is to be decided as per the needs of the analysis. Analysts normally take 100 DMA (100 day moving average) or 150 DMA or 200 DMA when the buy/sell signals are to be generated for long term investment. On the other hand, they normally take 10, 20 or 50 DMA when the buy/sell signals are to be generated for short term investment or for trading. In short, the period of DMA depends upon the investment horizon. Investors rely on the DMA for a longer period whereas the traders rely on the DMA for a shorter period. There is no hard and fast rule for a specific DMA to get the best or perfect results. One has to find out the correct DMA for a specific share or index by trial and error method. The method is actually used as mentioned below.
The DMA is calculated for the given historical data. Then a chart is plotted for the given period of time, stock prices and the DMA. The dates are shown along the X axis. The stock prices and the DMA are shown along the Y axis. The buy/sell signals are obtained as follows. A buy signal is generated when the stock price (or the index) line intersects the DMA line from below. It is also called as the breakout. On the contrary, a sell signal is generated when the stock price (or the index) line intersects the DMA line from above. It is also called as the breakdown. The longer period DMA generates less number of signals and the shorter period DMA generates a greater number of signals. Less number of signals can be relied upon to a greater extent. On the contrary, it is possible that a false signal is generated when a large number of signals are generated. The calculations of DMA for a short term and for a long term as well as the graphical representation of the data are explained in paragraphs to follow.
The basic concept used in this technique is the reversal of trend. The stock price (or the index) line slopes upwards to the right when the stock price or index is rising. As a result, the DMA line also slopes upwards to the right. At some point of time, the trend is reversed and the stock price (or the index) line starts sloping downwards to the right. However, the DMA line is still sloping upwards to the right. As a result, the stock price (or the index) line intersects the DMA line from above and generates a sell signal.
On the contrary, the stock price (or the index) line slopes downwards to the right when the stock price or index is falling. As a result, the DMA line also slopes downwards to the right. At some point of time, the trend is reversed and the stock price (or the index) line starts sloping upwards to the right. However, the DMA line is still sloping downwards to the right. As a result, the stock price (or the index) line intersects the DMA line from below and generates a buy signal.
Many reversals of trend are witnessed when the DMA for a short term is used and a very few reversals of trend are witnessed when the DMA for a longer term is used. It is possible to get a false alarm or signal when there are many signals. However, the probability to get a false signal is very low when limited signals are generated.
The DMA may be a simple DMA or an exponential DMA. The exponential DMA gives better results than the simple DMA. However, it does not mean that the simple DMA is not useful. Many people use the simple DMA in their analysis.
No comments:
Post a Comment