How do you choose which length and type of moving average to use for chart analysis? Take a look.
One commonly used technical
indicator is the moving average
(MA), which is plotted as a line
connecting the average of closing
prices over a lookback period.
Moving averages may be
used as trend indicators and to
identify support and resistance
levels and breakouts. The major
complaint concerning moving
averages is that they lag
changes in the trend and thus
lead to late signals.
Because of that flaw and their widespread use, many
articles have been written about moving averages. In most of
these articles, the writers discuss exotic forms of moving
averages that they feel are superior to the more common forms
because they reduce the lag or follow the trend closer. Some
common suggestions are methods to add an exponential factor
to the moving averages, weighting recent closing prices more
heavily, and using more than one moving average.
For mechanical trading systems, the length and type of
moving average chosen may be significant if it is backtested
and proved that, for example, a break above an x-length MA
has generated larger profits and smaller drawdowns than
other lengths; in such an instance, it may make sense to
choose one moving average length and type. But many
traders do not trade systems based on moving averages, while
there are others who use them only as guidelines in making
decisions about when to buy and sell. In such a case, how
should a trader choose a moving average length?
With respect to simple MAs, many lengths are popular
among traders, including but not limited to 10, 20, 21, 30, 50,
and 200 days. But why would these be any better than, for
example, 16, 24, 77, or 136? The obvious answer is that we
prefer round numbers, but is there any reason why a round
number would offer a trader more insightful information than
any randomly chosen number?