V.10:6 (275-278): The Basics Of Moving Averages by George R. Arrington, Ph.D.

The Basics Of Moving Averages by George R. Arrington, Ph.D.

Moving averages are one of the most common technical tools that technicians, both veteran and novice, may take advantage of. But for those novices, the concept may be somewhat confusing. What is a moving average, anyway? And what about all those variations — linear, stepweighted, exponential, even triangular? George Arrington explains the basics of the moving averages. And for those veteran traders out there, it never hurts to brush up on those basics.

The first maxim a trader learns is to "buy low and sell high." The trick, however, is to identify when the lows and highs occur and to act before others in the market. Trading profits go to those who are both correct and early. Trading losses go to virtually everyone else.

A moving average is probably the most common tool used by technicians to identify market trends. A moving average eliminates minor fluctuations in prices and helps identify any underlying trend (Figure 1). Moving averages may be constructed in a variety of ways. The most frequently used are, the simple, linear and exponential moving averages (see "Moving average calculations"), but others such as triangular and step-weighted moving averages are also used by traders.

The biggest difficulty in constructing a moving average is building one that is sensitive enough to signal when a new trend has begun (or when an old trend has ended), yet insensitive enough to ignore short-term random price movements (or "data noise"). If the moving average is too sensitive, random noise, can give false signals and generate unnecessary trades (whipsaws) and excessive commissions. There are several basic methods of applying data filters to data to segregate short-term random price movements from the underlying trend.