The longer the moving average, the more the lag. Moving averages lag because they are based on past prices.
Simple Moving Average Calculation
Short moving averages are like speedboats - nimble and quick to change. In contrast, a day moving average contains lots of past data that slows it down. Longer moving averages are like ocean tankers - lethargic and slow to change. It takes a larger and longer price movement for a day moving average to change course. Click on the chart for a live version. The day SMA fits somewhere between the and day moving averages when it comes to the lag factor. Even though there are clear differences between simple moving averages and exponential moving averages, one is not necessarily better than the other.
Exponential moving averages have less lag and are therefore more sensitive to recent prices - and recent price changes. Exponential moving averages will turn before simple moving averages. Simple moving averages, on the other hand, represent a true average of prices for the entire time period.
As such, simple moving averages may be better suited to identify support or resistance levels. Moving average preference depends on objectives, analytical style, and time horizon. Chartists should experiment with both types of moving averages as well as different timeframes to find the best fit.
The length of the moving average depends on the analytical objectives. Short moving averages periods are best suited for short-term trends and trading. Chartists interested in medium-term trends would opt for longer moving averages that might extend periods. Long-term investors will prefer moving averages with or more periods. Some moving average lengths are more popular than others. The day moving average is perhaps the most popular. Because of its length, this is clearly a long-term moving average.
Next, the day moving average is quite popular for the medium-term trend. Many chartists use the day and day moving averages together. Short-term, a day moving average was quite popular in the past because it was easy to calculate.
One simply added the numbers and moved the decimal point. The same signals can be generated using simple or exponential moving averages. As noted above, the preference depends on each individual. These examples below will use both simple and exponential moving averages. The direction of the moving average conveys important information about prices. A rising moving average shows that prices are generally increasing. A falling moving average indicates that prices, on average, are falling.
A rising long-term moving average reflects a long-term uptrend. A falling long-term moving average reflects a long-term downtrend. The chart above shows 3M MMM with a day exponential moving average. This example shows just how well moving averages work when the trend is strong. These lagging indicators identify trend reversals as they occur at best or after they occur at worst.
Notice that the day EMA did not turn up until after this surge. Once it did, however, MMM continued higher the next 12 months.
Moving averages work brilliantly in strong trends. Two moving averages can be used together to generate crossover signals. Double crossovers involve one relatively short moving average and one relatively long moving average. As with all moving averages, the general length of the moving average defines the timeframe for the system.
A bullish crossover occurs when the shorter moving average crosses above the longer moving average. This is also known as a golden cross. A bearish crossover occurs when the shorter moving average crosses below the longer moving average. This is known as a dead cross. Moving average crossovers produce relatively late signals. After all, the system employs two lagging indicators. The longer the moving average periods, the greater the lag in the signals.
These signals work great when a good trend takes hold. However, a moving average crossover system will produce lots of whipsaws in the absence of a strong trend. There is also a triple crossover method that involves three moving averages. Again, a signal is generated when the shortest moving average crosses the two longer moving averages. A simple triple crossover system might involve 5-day, day, and day moving averages. The black line is the daily close.
Using a moving average crossover would have resulted in three whipsaws before catching a good trade. This cross lasted longer, but the next bearish crossover in January 3 occurred near late November price levels, resulting in another whipsaw.
This bearish cross did not last long as the day EMA moved back above the day a few days later 4. There are two takeaways here.
First, crossovers are prone to whipsaw. A price or time filter can be applied to help prevent whipsaws.
Second, MACD can be used to identify and quantify these crossovers. MACD 10,50,1 will show a line representing the difference between the two exponential moving averages. MACD turns positive during a golden cross and negative during a dead cross. The first three resulted in whipsaws or bad trades.
A sustained trend began with the fourth crossover as ORCL advanced to the mids. Once again, moving average crossovers work great when the trend is strong, but produce losses in the absence of a trend.
Moving averages can also be used to generate signals with simple price crossovers. A bullish signal is generated when prices move above the moving average. A bearish signal is generated when prices move below the moving average.
Price crossovers can be combined to trade within the bigger trend. The longer moving average sets the tone for the bigger trend and the shorter moving average is used to generate the signals. One would look for bullish price crosses only when prices are already above the longer moving average. This would be trading in harmony with the bigger trend. For example, if price is above the day moving average, chartists would only focus on signals when price moves above the day moving average.
Obviously, a move below the day moving average would precede such a signal, but such bearish crosses would be ignored because the bigger trend is up. A bearish cross would simply suggest a pullback within a bigger uptrend. A cross back above the day moving average would signal an upturn in prices and continuation of the bigger uptrend. The stock moved above and held above the day moving average in August. Prices quickly moved back above the day EMA to provide bullish signals green arrows in harmony with the bigger uptrend.
The 1-day EMA equals the closing price. Moving averages can also act as support in an uptrend and resistance in a downtrend.
A short-term uptrend might find support near the day simple moving average, which is also used in Bollinger Bands. A long-term uptrend might find support near the day simple moving average, which is the most popular long-term moving average. In fact, the day moving average may offer support or resistance simply because it is so widely used. It is almost like a self-fulfilling prophecy. The chart above shows the NY Composite with the day simple moving average from mid until the end of The day provided support numerous times during the advance.
A breadth indicator derived from each day's net advances the number of advancing issues less the number of declining issues. As a momentum indicator, the McClellan Oscillator attempts to anticipate positive and negative changes in the AD statistics for market timing. Buy and sell signals are generated as well as overbought and oversold readings.
Traders may also look for positive or negative divergences to time their trades. A popular market breadth indicator that is ultimately derived from the number of advancing and declining stocks in a given market. A leading indicator measuring a security's rate-of-change. The ongoing plot forms an oscillator that moves above and below Bullish and bearish interpretations are found by looking for divergences, centerline crossovers, and extreme readings.
A volume-weighted momentum indicator that measures the strength of money flowing in and out of a security. The MFI is measured on a 0 - scale and is often calculated using a 14 day period. A three-day bullish reversal pattern that is very similar to the Morning Star. The first day is in a downtrend with a long black body. The next day opens lower with a Doji that has a small trading range.
The last day closes above the midpoint of the first day. A three-day bullish reversal pattern consisting of three candlesticks - a long-bodied black candle extending the current downtrend, a short middle candle that gapped down on the open, and a long-bodied white hollow candle that gapped up on the open and closed above the midpoint of the body of the first day. An average of data for a certain number of time periods. By definition, a moving average lags the market. An exponentially smoothed moving average EMA gives greater weight to the more recent data, in an attempt to reduce the lag.