Moving Average

Average price over a set period; smooths out short-term fluctuations.

A moving average is a widely used technical analysis indicator that helps smooth out price action by filtering out the "noise" from random short-term price fluctuations. It is a trend-following, or lagging, indicator because it is based on past prices. The two most common types are the Simple Moving Average (SMA), which calculates the arithmetic mean of a security over a specific number of periods, and the Exponential Moving Average (EMA), which accords greater weight to more recent prices. Investors and traders use moving averages to identify the direction of the current trend and to spot potential trend reversals. A rising moving average indicates that the security is in an uptrend, while a declining moving average suggests a downtrend. Moving averages are also frequently used to identify potential areas of support and resistance. When interpreting moving averages, a common pitfall is relying on them too heavily during sideways or range-bound markets, where they can generate numerous false signals (often called "whipsaws"). Additionally, because they are lagging indicators, they do not predict future price action but rather summarize past data, meaning they may react slowly to sudden, sharp market reversals.

To calculate a 5-day Simple Moving Average for a stock with closing prices over five consecutive days of $10, $11, $12, $11, and $13: SMA = (10 + 11 + 12 + 11 + 13) / 5 = 57 / 5 = $11.40. On the sixth day, if the stock closes at $14, the oldest price ($10) is dropped, and the new average is (11 + 12 + 11 + 13 + 14) / 5 = 61 / 5 = $12.20.