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Today we'll talk about how to use the moving averages.
But first we'll explain what is a moving average:
The formula is Price sum/Number of days.
Let's see for example this 5 sessions closing prices' moving average:
sum is 505
its value would be 101.
Let's say on the 6th day the share falls down to 95.
Current price would be 100.
With this we go on building the moving average curve.
There are many kinds: simple, exponential, weighted, etc which are different mostly on how much importance they put on the new data over the old. I use the simple one.
It can be used over closing prices as I usually do, but also opening prices, maximums, minimum prices, volumes, etc.
The moving averages are generally considered a lagging indicator, in that it doesn't allow us to anticipate the stockmarket, and the more sessions it consists of, the more inertia it has and the more sluggish it reacts to change.
That being said, it allows us to identify what is happening with a share or product at first sight.
Let's say we are considering wether to invest in a company or in some raw material like orange juice, but don't have much knowledge about either. To have a better idea, we compare the charts of the orange juice in the New York stockmarket with National Grid for the last decade or so and with the long moving averages of 1000, 200 and 50 sessions we more clearly see how each one behaves.
While the orange juice chart shows extreme movements in prices, due to being tied to the production and sales of oranges, and thus depends on climate and consumption which in turn means it depends on the economy; a company like National Grid provides a consistently needed service with long term contracts with large companies, and this reflects in its chart, generally bullish and much calmer. Personally, as a long term investor I definitely prefer to put my money in companies like National Grid.
How I use the moving averages:
-To detect long tendencies I use the 200 and 1000 sessions moving averages.
-To detect buying prices, I look at the periods when the 200 sessions moving average is below the 1000 sessions one, and the 50 sessions one below the other two.
-Once I find those I use the stochastic to adjust prices.
As always, best of luck in your investments.