Moving averages is a time-tested tool used by technical analysts.
It helps eliminate the noise caused by daily price fluctuations and gives a smooth data set to take better trade decision.
Here's all you need to know.
Note: Nifty 50 component analysis at end.
There are 2 types:
Simple moving Average (SMA or DMA):
Commonly used SMAs are the 20, 50, 100 and 200 day moving averages.
This price is simply computed by taking an average of the closing price for those number of days.
Eg: 50 DMA = Average of last 50 day price
Let us consider and calculate 5 Day moving average of Nifty50 for the last week.
Here the latest 5 DMA of Nifty 50 is 17,413.
As you see, average of March 2nd and March 3rd is different. The trendline keeps moving to the latest data point hence the name “moving” average.
How is this useful?
Moving averages are mainly used to determine support and resistance levels.
When price is below a moving average, it acts as a resistance
When it's above a moving average, it acts as a support
Let us understand this in a more simplified chart
While short term DMAs (5/20/50) act are near term support and resistance, longer term moving average such as 200 DMA act as strong support and resistance levels.
Consider trend for multiple moving averages on Nifty, the chart looks like this.
Moving Average crossover:
A more useful application of moving average is "Crossover" - indicates a change in trend.
There are 2 types of SMA crossovers:
Occurs when the short-term moving average trendline (say 50 DMA) crosses above a long-term moving average trendline ( say 200 DMA) from below.
This is considered a bullish
signal, suggesting a potential upward trend in the Index or any stock.
You can compare the 50-day and 200-day moving averages to watch for a golden crossover.
For reference: Look at this Nifty 50 crossover in August 2020. Post this crossover, Nifty50 had entered a very bullish trend which had lasted for over 1 year time period.
Occurs when the short-term trendline (say 50 DMA) crosses below a long-term moving average trendline ( say 200 DMA) from above.
This is considered a bearish
signal, suggesting a potential downtrend.
For reference, consider Nifty 50 chart of March 2020 We all have seen the famous COVID fall where the index had lost more than 40% of value in a short span.
We did a Nifty 50 analysis comparing latest 50 DMA and 200 DMA levels for each stock as of Mar 3rd.
1. Divided 50 DMA levels /200 DMA levels
2. If value >1, the stock chart last had a Golden cross
3. If value <1, the stock chart last had a Death cross
We have tabulated here recent trend of Nifty 50 stocks based on Moving average analysis.
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Note: Not a trade or investment advice.
That's the end of this thread. We will explain how to supplement this with Exponential moving average next.
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