Comparing moving averages

The moving average is a fundamental tool for smoothing price action and revealing trend. In the early days of technical analysis, traders simply looked for a crossover of the moving average (i.e., when price crosses above or below its average) as a sign the trend had changed. Today, traders have shorter-term trading horizons, so the moving average is also used as a “decision filter.” For example, if price is above its moving average, then the trend is up, and the trader will look for short-term buy setups (rather than sell setups).

Although moving averages can simplify price action and highlight the underlying trend, they also trail behind (lag) price action — the longer the moving average, the more it lags price. There are several types of moving averages; traders originally used the simple moving average (SMA) because it was easy to understand and calculate. Over time, other smoothing techniques were incorporated to reduce the lag inherent in the SMA. Here, we will compare the three most common moving average types — simple, weighted, and exponential.

There is no “correct” number of bars to use in a moving average. Certain “look-back” periods have become popular over time (e.g., the 50-day and 200-day moving averages), but there is no moving average length that will best reflect the trend in all conditions and markets. The following examples use several representative moving average lengths.