Moving averages are amongst the most popular and versatile indicators used by traders. They are used by many as criteria for entry (MA crosses) as a way to manage a trade in a trending market and as ‘dynamic’ Support and Resistance. Moving averages smooth the price data to form a trend following indicator. They do not predict price direction, but rather define the current direction with a lag. Moving averages are based upon past prices, which means that they will lag behind current prices. Price leads and the Moving average follows. They offer traders a dynamic form of Support and Resistance the major numbers 20, 50, 100 and 200 period moving averages are the most used.
Simple Moving Averages
We factor the 20,50,100 and 200 simple moving averages into our calculations of Support and Resistance. A simple moving average is formed by computing the average price of an instrument over a specific number of periods. Most moving average are based on the closing prices. A 20-day simple moving average is the twenty day sum of closing prices divided by twenty. As its name implies, a moving average is an average that moves. Old data is dropped as new data comes available. This causes the average to move along the time scale. On day 21 of a 20-day SMA, the first day would be dropped from the calculation and the twenty first day would be added.
Exponential Moving Averages
We factor the 20,50,100 and 200 exponential moving averages into our calculations of Support and Resistance. Exponential moving averages reduce the lag by applying more weight to recent prices. The weighting applied to the most recent price depends on the number of periods in the moving average. There are three steps to calculating an exponential moving averages. First, calculate the simple moving average. An EMA has to start somewhere so a simple moving average is used as the previous period's EMA in the first calculation. Second, calculate the weighting multiplier. Third, calculate the exponential moving average.