Page 208 - THE MARKET WHISPERER
P. 208
204 PART 7 - Indicators: The Trader’s Compass
Moving Averages
As we learned, stocks do not rise in a straight line, but in zigzags. This is the
nature of the trend. Part of the natural process of reaching highs involves
pullbacks. A stock in an uptrend and correcting is still a stock following its
trend, and this is how we should view it.
Of course, not every low will be accepted with forgiveness, which means
we need an assistive tool for defining the trend. Moving averages (MA) are
tools that assist in defining the trend and warning of possible reversals.
Their role is to flatten the zigzag and make it easier to read the trend.
Unlike other indicators that will be described further on, the information
provided by the MA is unequivocal and makes reaching conclusions easy.
The MA is computed according to the averages of closing prices for a
defined period, and appears on the line chart as a continuous line. By way
of reminder, the “closing price” is the price at which the last trade was
made for the period being examined. For example, this could be the closing
price for the trading day if the timeframe is in days, or the price of the last
trade if the timeframe is five-minute candles.
The average is called moving because the average of closing prices is
computed for each time within the period being checked. An example is a
moving average known as a “10 period MA” on the daily chart. The average
of closing prices for the past ten days is computed. In this way, the average
“moves” each day according to the closing price of the day being added on
to the previous nine days. The closing price is the basis for calculating the
MA, since the closing price is the most important data.
Sample Calculation
Exercise: Calculate the 10 period moving average (10MA) at the end of
the 10th day for a stock that rose from $10 to $20 with a spread of $1 per
day over 10 consecutive days.
Answer: Let’s add up the closing prices of the past ten days:
11 + 12 + 13 + 14 + 15 + 16 + 17 + 18 + 19 + 20 = 155
The average for 10 days is 155/10 = 15.5
In other words, the MA at the end of the tenth day is 15.5, and is written
as follows:
