Moving Averages

Aspen offers five moving averages:

Moving averages are lagging indicators.

Moving averages smooth out a data series and make it easier to identify the direction of the trend. Because past price data is used to form moving averages, they are considered lagging, or trend following, indicators. Moving averages will not predict a change in trend, but rather follow behind the current trend. Therefore, they are best suited for trend identification and trend following purposes, not for prediction.

Because moving averages follow the trend, they work best when an instrument is trending and are ineffective when a security moves in a trading range. With this in mind, investors and traders should first identify securities that display some trending characteristics before attempting to analyze with moving averages. This process does not have to be a scientific examination. Usually, a simple visual assessment of the price chart can determine if a security exhibits characteristics of trend.

In its simplest form, a security's price can be doing only one of three things: trending up, trending down or trading in a range. An uptrend is established when a security forms a series of higher highs and higher lows. A downtrend is established when a security forms a series of lower lows and lower highs. A trading range is established if a security cannot establish an uptrend or downtrend. If a security is in a trading range, an uptrend is started when the upper boundary of the range is broken and a downtrend begins when the lower boundary is broken.

Two popular applications of moving averages are:

Trend identification/confirmation
Support and Resistance level identification/confirmation

There are three ways to identify the direction of the trend with moving averages:

direction
location
crossovers.

The direction, up or down, of the moving average identifies trend. If the moving average is rising, the trend is considered up. If the moving average is declining, the trend is considered down. The second technique for trend identification is price location. If the price is above the moving average, the trend is considered up. If the price is below the moving average, the trend is considered down. The third technique for trend identification involves the use of two moving averages of different lengths. If a shorter moving average is above a longer moving average, the trend is considered up. If a shorter moving average is below a longer moving average, the trend is considered down.

Another use of moving averages is to identify support and resistance levels. This is usually accomplished with one moving average and is based on historical precedent. As with trend identification, support and resistance level identification through moving averages works best in trending markets.