What is a Moving Average?

By James Brumley

Veteran investors as well as newcomers to the stock market will equally appreciate the versatile clues provided by a stock’s moving average. What’s a moving average as it relates to an investment? It’s a technical indicator that anyone can use, and everyone should.

What’s a Moving Average? A ‘moving’ average is the average closing price of a certain stock (or index) over the last ‘X’ days. For instance, if a stock closed at $21 on Tuesday, at $25 on Wednesday, and at $28 on Thursday, its 3-day moving average would be $24.66 (the sum of $21, $25, and $28, divided by 3 days).

Since the most recent X-day period changes every day, so too will the value of the stock’s moving average. The ongoing updates to the moving average value are also sometimes called a ‘rolling’ average.

Moving averages are usually plotted on a stock’s chart by those who are analyzing them, since their physical position in relation to the stock’s price is the key to using them effectively. As for how many daily prices a moving average should incorporate, the chosen moving average length (or X days) should reflect the investor’s intended holding period and time frame.

How is it Interpreted? First and foremost, investors should understand the purpose of a moving average is to ‘smooth out’ erratic day-to-day price changes into something more discernible and consistent. With that in mind, there are several ways to use them as an investor. There are the three basic, core strategies though:

1. Momentum Indicator – Is the moving average pointing upward, or downward? It does indicate the bigger trend, after all.

2. A ‘Signal’ Line – A stock that crosses above or below a selected moving average line could be considered a simple ‘buy’ or ‘sell’.

3. Support or Resistance Levels – A stock that moves back towards a moving average line may not necessarily cross it again; that moving average could also be a reversal point.

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