Investing in stocks while building a diversified portfolio can help you build wealth over the long-term. There are a number of indicators you can use to analyze stocks when deciding where to invest, including the moving average. A stock’s moving average represents its average price over a set time period, which can be anywhere from a few days to a few months. If you’re interested in using a technical analysis approach to vet equities, it’s helpful to know what the moving average means and what it tells you about a stock’s price. A financial advisor can also help you with building a diversified portfolio.
What Is a Moving Average?
Share prices aren’t static; they can fluctuate up or down over time as market conditions change. Technical analysis is a way for investors who buy and sell stocks to understand how market trends affect stock pricing using various indicators, which include moving average.
A moving average represents a series of share price averages over time. A stock’s pricing chart may be characterized by spikes and declines, rather than moving in the same direction consistently. Using a moving average to analyze price movements can make it easier to see at a glance which way a share price is trending up or down.
It’s called a moving average because it can change over time as a stock’s price changes. Because it relies on looking backward at stock pricing, moving average is a lagging indicator. It’s generally used to confirm how a stock’s price has been trending, though it doesn’t necessarily guarantee that a particular trend will continue.
How Moving Average Works
Calculating the moving average begins with choosing a specific time period to analyze. This can be a relatively short period of time, such as five to seven days. Or you may look back further over a three- to six-month period.
To find the moving average of a stock, you’d take all the prices it traded at for your chosen time period then divide it by the total number of periods. Again, it’s up to you to decide what time period you want to measure. If you’re an active trader, for example, you may be more concerned with short-term pricing movements. On the other hand, if you learn more toward a buy and hold approach you may want to analyze price trends over a longer window.
Once you have a moving average for a specific stock, you can then gauge the momentum of the stock’s pricing. Again, a moving average can indicate an upward trend with prices rising steadily, or a downward trend where prices are declining. It’s also possible to gauge whether a stock’s price is experiencing a bullish or bearish movement, based on how the moving average is trending.
Simple Moving Average
There are different types of moving averages you can use to analyze pricing trends. The simple moving average or SMA allows you to use recent price averages to view stock trends. You can use SMA to compare trends for high or low prices or a share’s price at open or close over a set time period.
A simple moving average is most often used to track short-term trends. For example, you might use it to study price averages for the previous five-day trading period. SMA is often used as an indicator for short-term trading strategies when deciding whether to buy or sell a particular security.
Exponential Moving Average
An exponential moving average or EMA looks at a stock’s most recent pricing to measure trends. EMA is also known as a weighted moving average since more weight is given to the most up-to-date pricing data. To find EMA, you’d first find a stock’s simple moving average for a given time period. Then you’d assign an exponential factor, also known as a smoothing factor, to calculate the exponential moving average.
The main difference between EMA and SMA is that SMA weights all price trends the same while EMA does not. Using an exponential moving average may be preferable if your trading strategy is focused on the most recent market developments.
Moving Averages and Other Technical Indicators
In general, moving averages are designed to help you detect long-term pricing trends for stocks. Looking at different time periods in a stock’s pricing history can make it easier to read buy or sell signals and decide what to do with a particular security. For instance, if a stock is trading above its 50-day moving that could signal that its price should remain consistent or continue to increase over time.
Moving averages can be helpful when a stock is experiencing an upward or downward trend but they aren’t the only technical indicator you can use to evaluate shares. Relying on moving averages alone could be risky if they give off conflicting trading signals that make it unclear whether you should buy or sell a specific stock.
When comparing moving averages, it’s also helpful to look at momentum indicators, volatility indicators and volume indicators. These indicators look at the speed and rate of stock prices as well as the numbers in which a stock is being traded. Collectively, these kinds of technical indicators can help you build a more complete picture of which way a stock is moving and likely to move in the near-term.
You may also want to double-up on your analysis by looking at stock fundamentals as well. Fundamental analysis focuses on key indicators of a company’s financial health, rather than watching trends. For example, if you’re using fundamental analysis to compare stocks you might look at things like the price to earnings ratio (P/E ratio) or earnings per share (EPS).
Fundamental analysis and technical analysis aren’t mutually exclusive; you can use both to evaluate which stocks to add to your portfolio or when to buy and sell. Each one offers a different view of the same stock, which can make deciding where to invest easier.
Bottom Line
The moving average of a share is a relatively simple way to compare pricing trends over time. There are different ways to calculate the moving average, which is a form of technical analysis, and it can be used alongside other indicators, such as those of fundamental analysis, to guide your investment strategy. Just keep in mind that no analysis is foolproof and that investing in stocks always involves a certain amount of risk.
Tips for Investing
- Consider talking to a financial advisor about what moving average means and how to use it and other indicators when deciding how to invest. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- An investment calculator can augment your analytical resources as you decide what and when to trade equities. Aside from stocks, you may also choose to invest in mutual funds, exchange-traded funds, bonds, real estate and other securities. An online brokerage account can be a cost-efficient way to invest if you’re able to trade stocks, ETFs and other securities commission-free.
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