One of the simplest yet most effective tools in the technical analysis arsenal is the Moving Average (MA) which assists traders in determining the overall trend of a market. The MA takes the price data and averages it over a specified time period thus removing the short-lived price movements from the market analysis. Hence, one can easily see the trend and the noise created by sudden price swings is minimized.
Different moving averages exist, but basically they all do the same thing: they indicate the price movement’s overall direction. To monitor recent activity, a trader may adopt a short-term MA, such as 20 or 50 periods, while longer MAs, such as 100 or 200 periods, are used for recognizing broader trends.
A moving average usually indicates strength or bullishness when price moves above it, but it can also mean weakness or a bearish trend when it drops below. Besides that, traders always keep an eye on the interaction of different moving averages. For example, when a shorter MA cuts through a longer MA from below, it could be interpreted as a transition to an uptrend.
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Although moving averages do not give price forecasts, they are able to clarify market behavior for traders. Simply put, an MA indicates the direction the market has been taking thus allowing one to easily detect trends and consequently trade with more assurance.