I. Defining moving averages and their purpose

The moving average (MA) is a fundamental tool in technical analysis that averages out price data over a designated period, such as 20 minutes, 10 days, 30 weeks or any preferred period the trader chooses to produce a continuously updated average price.

This technique helps smooth out price fluctuations and provides a clearer view of the trend direction. MAs can be customised to any timeframe, making them versatile for both short-term trading and long-term investment strategies.

II. How they help

MAs help clarify market trends by filtering out minor fluctuations that can distract from the main price movements, thus providing a smoother perspective on the trend direction. This tool is crucial for traders and investors, aiding them in spotting trend continuities and reversals.

For example, during an uptrend, an MA over 50, 100 or 200 days might serve as a support level, creating a "floor" that the price tends to bounce off. Conversely, in a downtrend, it can act as a "ceiling" or resistance level, where the price reaches it and then declines (Figure 1). 

Figure 1: Support & Resistance

However, it's important to note that the price may not always adhere strictly to these levels and  might fluctuate without reaching the support or resistance level. Generally, if the price remains above the MA, the trend is considered upward, and if it is below, the trend is regarded as downward. 

III. Common types

Each MA has a different calculation. For instance, a five-day Simple Moving Average (SMA) sums the five latest daily closing prices and divides the total by five to generate a new average each day. These averages are then connected to form a continuous line. 

Another common type is the Exponential Moving Average (EMA). Its calculation is more intricate, as it gives more weight to the most recent prices. When plotting a 50-day SMA and a 50-day EMA on the same chart, the EMA will respond more rapidly to price changes than the SMA due to the increased emphasis on recent price data (Figure 2).​​ 

IV. Performing calculations

Charting software and trading platforms perform the calculations, so users do not need to do any manual math to use an MA. The CSX Trade app, developed by the Cambodia Securities Exchange (CSX), also includes automatic calculation of MAs and offers three different time scales: 5 days (MA5), 10 days (MA10) and 20 days (MA20) (Figure 3).

Figure 2: Simple Moving Average vs Exponential Moving Average. Figure 3: CSX Trade.

V. Timeframes

The various lengths of MAs used in trading accommodate different strategies and time scales. Typical lengths include 10, 20, 50, 100 and 200 days, applicable to chart timeframes ranging from minutes to weeks. 

The timeframe, also known as the "look-back period", of an MA affects how closely it tracks price changes. Short-term traders prefer a 20-day MA for its quick responsiveness, while long-term traders favor a 100-day MA for smoother trend indications. 

By tuning the length of the MA to better match historical data, traders can improve its predictive accuracy.

VI. Key strategies

Key strategies involving MAs include crossovers. A price crossover is when the price moves above or below a MA, signaling a potential trend change. Another strategy uses two MAs: a short-term and a long-term MA. A “golden cross” signals a “buy” when the short-term MA crosses above the long-term MA (Figure 4), while a “death cross” signals a “sell” when the short-term MA crosses below the long-term MA (Figure 5). 

Figure 4: Golden Cross. Figure 5: Death Cross.

Despite their benefits, MAs have limitations. They are lagging indicators, relying on past data, which can delay signals and reduce the probability of strategy profitability. MAs are effective in clear trending markets but perform poorly in choppy conditions, specifically during market volatility. 

For more effective trading, MAs should be part of a comprehensive system that includes other indicators to confirm trends and account for overall market conditions. 

***Disclaimer: This article has been compiled solely for informative and educational purposes. It is not intended to offer any recommendations or as investment advice. The Securities and Exchange Regulator of Cambodia (SERC) and Post Media Co Ltd are not liable for any losses or damages caused by using it in such a way.

Prepared by: Securities and Exchange Regulator of Cambodia, Department of Research, Training, Securities Market Development and International Relations

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