Moving Average Introduction

Do you want to know exactly how to use moving averages in your trading to improve your results? My name is Adrian Reid and I'm the founder of Enlightened Stock Trading. And in this video and this video series, I'm going to give you everything you need to know about moving averages. But before we go any further, make sure you hit the subscribe button and give this video a thumbs up so that you get notified of all of my future videos. Because I've got new trading content coming out all the time and I don't want you to miss a thing. So what is a moving average and what is it used for? Well, in essence, a moving average is an indicator that you use on your trading charts to help gauge the direction of the price movements. Now how do we calculate, let me show you on the screen here what a moving average looks like and how explain how it's calculated. We'll start with a simple moving average and then we'll get into the other moving averages as we go. So on the chart I've got a chart of the SPX index, the S&P 500 index, and I've overlaid a 10 day moving average on the index. So, so what is a 10 day simple moving average? How does it work? Well, if you look down here on the right hand side, I've got this red box to highlight some of the bars and you'll see that the moving average is a line that runs sort of alongside the price of the instrument that you're charting. And in order to calculate the moving average on each day, the simple moving average, what you need to do is average, do an arithmetic average of the last X number of bars of, of that price series that you're plotting. So see we've got the S&P 500. This is a 10 day moving average. So I've drawn a red box here around the last 10 bars. Let's count them here. We've got 1, 2, 3, 4, 5, 6, 7, 8, 9, 10. And so to get this point here, the Most recent moving 10 day moving average, you take the closing price on each of the last 10 days, you add them up and then divide it by 10. And then you plot the result here to get this, the previous bar's moving average, which is one day ago, same sort of thing, you take the last 10 bars, which is this 1, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10. So it includes the previous bar that wasn't in today's calculation and you add up the closing prices and you divide it by 10. Now you don't always have to do the moving average of just the closing price. You could have a moving average of the open, the high, the low or the close or, or the moving average of some calculation of those like the average of the open, high, low, close, for example. So there's lots of different ways you can calculate the moving average. And on this chart here we've got a simple moving average and it's 10 bars. So a 10 bar moving average is quite a short term moving average. We could also overlay a much longer term moving average. Let's put a 200 day moving average and 200 days is interesting because the 200 day moving average is one of the most useful tools in technical analysis and I'll be talking about that more shortly. But you can see here the 200 day moving average which is calculated exactly the same as the 10 day moving average but instead of averaging the last 10 days of data, it's averaging the last 200 days of data. So it's a much slower moving moving average. And so you can see here, it's a nice gradual trend. The 200 day moving average right now as of the time I'm recording this video is moving down and, and the price is below the 200 day moving average. And that has some very special significance for traders and investors because below the 200 day moving average bad things tend to happen and the markets are much more volatile. Above the 200 day moving average the market is generally much less volatile and trends much more smoothly. So bull markets happen above the 200 day moving average and bear markets and crashes tend to happen below the 200 day moving average. So 200 day moving average is one of the most powerful signals in technical analys. So I'm going to talk more about that further down this page or later on in this video series on moving averages. So this is how you calculate a moving average, but there's several different types of moving averages. So I want to show you these on the chart now for some comparison. There's a simple moving average, there's an exponential moving average, a weighted moving average and a TEMA moving average. Tama. Now each of these have different pros and cons and again I'll get into all of the detail of those later on. But I just want to illustrate right now some of the differences the way it appears in the chart. So I'm going to drag a exponential moving average and I'm going to make a 200 day exponential moving average and I'm going to put that in blue. Let's make it thick so we can see it. And if we compare the 200 day exponential moving average to the 200 day simple moving average which is in black on this chart, you can see that the 200 day exponential moving average is a little more responsive. It's a bit closer to the price. And the same thing happens if you take a short term moving average. Let's take a 10 bar exponential moving average and we can compare it to the 10 bar simple moving average. You can see if I zoom in, let me zoom in here. You can see that the 10 bar exponential moving average hugs the price a little more closely than the simple moving average. So for the same number of bars, the 10 bar exp. Sorry. The exponential moving average for the same number of bars hugs the price more closely and is more responsive than the simple moving average. That doesn't make it better, it just calculates differently. And I'll go through the calculation of the exponential moving average later on in this video series. So that's the exponential moving average. Let's have a look at the weighted moving average. And again I'm just going to zoom out here and I want to drag a 200 bar weighted moving average on to the chart and you can see the weighted moving average behaves differently to both the simple and the exponential moving average. Here it is here. So I've put the simple moving average in black, the exponential moving average in blue and the weighted moving average in green. So it has some quite different characteristics depending on what you want to do. Now a lot of people will ask what is the best moving average to use. And to be honest, there is really no best moving average. It depends on what you are trying to use it for. And you can really investigate which moving average works best for your purpose. Whether you're using it in your system for a trend filter or for an entry signal or a trailing stop or various different things. Different moving averages will perform different functions. And one of the best things you can do is learn how to back test your rules and your ideas so you can figure out what is the best moving average for you for your use case for your particular trading strategy. So these are some of the different moving averages. We've got simple exponential weighted. I also showed you also saw that there's a TEMA that's a triple exponential moving average. This is even more complex. I'll just put a long term TEMA on here and again I'll make that fixed so that you can see it. I'm doing all of this plotting on amibroker you might use other charting software. Amibroker is what I use for charts and for backtesting. So the TMA is an attempt to speed up and make the moving average more responsive. One of the challenges with moving averages is that they tend to be quite slow and laggy. The TMA is a calculated. It's a moving average of a moving average of a moving average. And it's a complex calculation which I'll explain shortly that takes a combination of the original exponential moving average, the EMA of that moving average and the EMA of that moving average and combines them to try and reduce or remove some of the lag. You can see here this purple line on the chart here it is here. So now we've got the simple moving average in black, the exponential moving average in blue, the weighted moving average in green, and the tema, the triple exponential moving average in purple. And if we zoom in here, you can see that the TEMA is quite responsive to price. It moves quite quickly in line with the price. Certainly can, compared to the simple moving average and the exponential moving average and even the weighted one here in this case. But I want to be clear and emphasize that just because it's more responsive doesn't mean it's better, it's just different. And you need to back test your system ideas using each of these different moving averages and see which gives you the best signals. So there are the different types of moving averages. In the next video, I'm going to go through in a bit more detail what all the different types of moving averages are. So if you want to know more detail about how the different moving averages work and what they're used for, watch this video now and I'll see you over there. So click this video and I'll explain to you all about what the different types of moving averages are and how they work.