When you’re trading stocks or any other type of security, it’s vital to keep track of their performance.
While you don’t want to overreact to short-term price fluctuation, you do need to ensure your investment is going up, not down, and to measure the rate at which the price is moving (unless you are in a ‘sell’ trade – shorting).
One of the most popular tools for checking movement over a given period of time is called the ‘moving average’.
This will give you the average price of a stock over a set number of days, depending on your investment horizon. This works whether you’re a short-term or a long-term investor.
Simple moving average
Sometimes known as the ‘simple moving average’ (there are more complex versions, such as the exponential moving average, or EMA) this can help cut through the volatility on a stock chart by showing long-term trends as a single line, rather than just seeing the noise of frequent fluctuations.
If you’re a short-term trader, then you will want to keep a close eye on a 10-20 day moving average – this is the average of the price movement over a set number of days, and will change each day (see table below).
A moving average of 30-100 days will give you a medium-term snapshot, while for longer-term investors, 100-plus day moving averages will give you a good feel as to how the stock is performing over a longer timescale.
Example of a moving average formula
Day Closing price 10-day MA Formula
- 169 160.2 Average days 1 to 10
- 166 161.8 Average days 2 to 11
- 167 163.0 Average days 3 to 12
- 168 164.1 Average days 4 to 13
- 169 165.0 Average days 5 to 14
- 170 165.5 Average days 6 to 15
- 174 167.0 Average days 7 to 16
- 172 168.0 Average days 8 to 17
- 175 169.5 Average days 9 to 18
- 177 170.7 Average days 10 to 19
- 180 171.8 Average days 11 to 20
You can also compare short-term trends with long-term trends by looking at the crossover between, say, a 10-day moving average and a 100-day average.
If you plot them on the same graph, if the 100-day average is moving steadily upwards, and the 10-day is moving downwards, there is some short-term selling occurring.
If it crosses downwards over the plot of the longer-term average, then there is a downward trend occurring, and it’s called a bearish crossover. Similarly, if the short-term moving average crosses the longer-term plot in an upwards direction, it’s known as a bullish crossover.
You can take this process one stage further. Rather than just analysing historic trends, you can also spot new trends under way. If current prices are significantly above a rising moving average, it suggests the stock is in an upward trend, while if prices are below a falling moving average it’s in a downward trend.
You can elaborate on this process to see whether recent price movement is just a blip, or part of a longer-term trend. If you plot short-, medium- and long-term moving averages on a chart, if the short-term moving average is diverging from the longer averages, it indicates a new trend in process.
If it is rising strongly above the longer averages then it is in an upward trend, while if it is dropping below falling averages, then it is in a downward trend.
This type of analysis is particularly useful in short-term trading, especially when you are using contracts for difference (CFDs), where you can sell or ‘short’ falling stocks.
However, it’s also useful for longer-term investing, where you may not wish to buy stock unless you can be confident it is outperforming a long-term moving average.
Support and resistance
Moving averages will also often support a trend. Stock prices fluctuate on a minute-to-minute basis, and if you look at a chart you will see a series of peaks and troughs.
Overlaying short- and medium-term moving averages as lines on the chart, the troughs or ‘pull-backs’ will frequently stop at the moving average before rebounding, as professional traders anticipate the stock’s next move.
Equally, if a stock falls below the trend indicated by a moving average, it often struggles to bounce back above the average. This is known as resistance.
You can also use this method of observation to set stops on your trading platform below (if you’re buying) the moving average of your choice, depending on your investment horizon. This prevents you being stopped out of the trade too easily due to random price spikes.
Gauging just how far below the moving average will come with experience, which is why it’s useful to have a dummy account before you start trading with real cash.
Moving averages should be considered an essential part of your toolkit as a trader, enabling you to thoroughly research price movements and trends before making a trade.
See also exponential moving averages.