MAs are very popular in technical analysis and serve a variety of purposes. Here are some uses:
- Moving Averages help to smoothen out the price action. It helps to cut out the short-term noise.
- They help in identifying trends. This is another essential function of moving averages. For instance, a 200-Day Simple Moving Average (SMA) is an arithmetic average of the last 200 period closing prices on a rolling basis. If the current prices are above this average price, it is safe to assume that the market is trending up. There are a variety of moving averages (Most notably, the Exponential Moving Average) to help arrive at specific conclusions about the trend.
- They help in identifying the rate of change in the trends. For example, using a longer period SMA and a shorter period SMA helps identify which trend is moving in the short term relative to the security's long-term trend. Analysts also use SMA & EMA crossover to determine the strength of the trend as EMA places a higher weight on recent periods and thus gives an early sign of things to come.
- They are used to construct indicators.
- They act as support & resistances as prices tend to hover around the moving averages, indicating that the market participants pay attention to important levels. This is applicable both in the long term and the short term.
- They can be used for placing stop losses and also trailing stop losses along with the trend. The periodicity is determined by the duration of the trade, risk appetite and ultimately, its effectiveness. For short-term traders, generally, a shorter-term MA is used to trail stop losses.