Short term moving averages and longer term moving averages can be combined on a single chart.
The chart below shows a 5 day moving average plotted alongside a 20 day moving average for Cadbury Schweppes.
Click here for the full size graph.
The normal 'rule' for this type of combination is:
You can see these signals quite clearly on the Cadbury Schweppes chart.
The rationale is that the shorter average (in this case 5 days) represents what the market thinks of the stock right now. The longer average (in this case 20 days), represents its view over a longer period.
If the shorter average is above the longer moving average then 'current' market expectations are for a higher share price. But if the longer average is above the shorter average the market expect the share price to decrease.
To show that this form of interpretation does, indeed, work, look at the chart below. This is the Cadbury Schweppes chart again, with the moving average lines removed but the buy and sell signals superimposed on top of the actual share price line.
Click here for the full size graph.
As you can see, if you'd bought and sold at the times indicated by the moving average signals, you would have made successive trading profits.
Some investors take it a step further, and plot three or more moving averages on a chart. These charts tend to be more difficult to interpret and produce many false starts. Unless you are an experienced investor, it's best to leave them well alone.
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