Magic of Moving Averages
What is a Moving Average?
A Moving Average can be described as the average of a time series. An average comprises of data, and data with respect to stock markets signifies the market data consisting of price and volume.
Lets understand this concept in detail with the help of an example of the Indian Cricket Team. They’ve scored a certain number of runs in the last 10 games of T-20 matches. We can record the runs scored in these last 10 matches played. So in the first match, the team scored 160 runs, then 150, 210, 120, 150, 155, 140, 180, 210, 190. Now after looking at the above runs scored in the past 10 matches, Can we predict what will be the score in the 11th match approximately? Statistically, the average number of runs scored in each match is 166 runs.
So we can say most probably the approximate number of runs which can be scored in the next match would be around 166 runs.
With reference to stock prices, when we talk about prices, we divide the price into specific fields of - Open, High, Low and Close.
Normally we take the closing price of a given period while calculating Moving Averages because closing price plays a vital role in determining the psychology of people towards a stock.
For example, we want to calculate the 5-day moving average price of Reliance Industries Ltd.
We will simply take the closing price of Reliance Industries for the last 5 days and divide it by 5.
We can plot moving averages of any time frame. We will discuss the time frame and moving averages later in this module.
The above image shows us the daily prices of SBIN, with a 13-day Moving Average (Blue Line), and a 30-day Moving Average (Green) plotted.
We can see, the 13 day moving average of SBIN is closer to its price than the 30 day Moving Average.Hence, we can make a statement:
Smaller time frame Moving Averages are closer to the price when compared to higher time frames. Higher time frames are smoother and flatter when compared to smaller time frames.