Moving averages, in stock market parlance, are only an extension of the average calculation most of us may have learnt at school. An average is the ratio of the sum of data to the number of data points. It helps in arriving at an approximate number that helps to make a decision.
Moving averages are an extrapolated version of a simple average. These are used to decide on stock buying and selling. It is called so since the time frame that we can use for making decisions can be moved. There is a 5-day moving average, 50-day moving average, or even one with a 20-minute time frame.
Moving averages are used as part of technical analysis to help an investor smoothen the stock price trend by taking off the daily price movements to make an informed and calculated decision.
When it comes to stock analysis, there are mainly three types of moving averages:
A simple moving average requires the average price of a stock across different timelines. It primarily uses closing prices of stocks. As a first step, it requires one to estimate the average prices of a stock as of given time periods. The next step is to divide the sum of prices by the total number of time periods. Let’s understand this with the help of an example:
Suppose Nisha wants to know the simple moving average for Stock ‘A’. For this, she considers the closing prices of the stock for the past 5 days.
The closing prices are Rs. 25, Rs. 26, Rs. 23, Rs. 24.9 and Rs. 25.3
The SMA can be computed as:
SMA = Rs. (25 + 26 + 23 +24.9 + 25.3) / 5 = Rs. 24.84
A weighted moving average (WMA) helps in covering for some of the flaws of SMA by adding more weightage to recent data rather than the past. WMA strictly uses the different price levels of a stock than SMA.
This moving average is also referred to as EMA. It uses complex calculations, however, just as WMA, EMA adds more weightage to the latest stock prices. If EMA and SMA are compared for the same time periods, the former shows faster reaction than the latter due to more emphasis on the recent stock prices.
Moving average plays an important role in stock markets, especially while making buy-and-sell decisions. As more investors focus on this calculation, most app-based trading platforms today contain a chart option reflecting moving average information.
There are various reasons why one should use moving averages while deciding on buying or selling of stocks.
Stock markets in India widely make use of moving averages since it is a good indicator of stock performance. Without worrying about minute details, investors can look at the moving average graph and know the stock price prediction. It allows one to buy the right stocks and wait for it to fetch good returns before exiting the investment.
While moving average gives a quick and easy view on price trends of financial instruments, here are some of the factors that one must keep in mind while using them:
For a new investor who has started learning to trade, using moving averages as part of technical analysis can prove to be complicated. Before adopting this strategy for stock selection, it is important to know the basics of the market and how it functions.
You can learn the basics of technical analysis for stock investments online in India, as there are many platforms offering this information.
Fundamental analysis is mainly used to determine the quality of long-term investments, while technical analysis is to review short-term investment decisions while actively trading in stocks.
To analyse stocks for investments, beginners can study the company’s financial ratios, understand the company, go through the company’s financial results, analyse future prospects, and historical trends.
Yes, you can invest as little as Rs. 100 in share markets as there are many stocks under this price and there is no limit on the minimum number of shares you have to buy.
To invest in stocks, you need to have a trading and Demat account, both of which can be opened with the help of a broking platform. With a bank account linked to these, you can begin investing in stocks.
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