Technical analysis II

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2. Moving averages

To calculate the moving average, you start by taking the simple average for the first seven days worth of data. This is the calculation we did on the previous page, and the figure was 276. It is the first point on your moving average chart.

To get the second point, deduct the value for Day 1 and add the value for Day 8 - in other words calculate the simple average for Days 2 to 8 inclusive. On the figures we've used, the total for Days 2 to 7 is 1915 and the average is 273.6.

To get the third moving average point, use the figures from Days 3-9, to get the fourth use Days 4-10 and so on.

What you end up with is a graph that depicts the changing average price of the share over the time period you have selected.

In our example, we've used a 7-day moving average which is fairly short term. Technical analysts also use medium term and longer term moving averages, typically 14 days and 20 days.

• The higher the number of days used, the less effect each daily change will have on the moving average, and the smoother the chart will be.
• The lower the number of days used, the greater the effect of each daily change on the moving average, and the more volatile the chart will be.

So with one set of data, you can get several different types of chart. Some technical analysts prefer to use long term moving averages because the smoother chart throws up fewer 'false starts'. It only signals price trends which have some depth to them, and which therefore have 'authority'.

Others argue that by the time a long term moving average chart actually signals a trend, most of the price change has already passed. They say that to pick up a trend early, you need to use short term averages.

In practice, there is no reason why investors cannot look at a chart based on 7-day, 14-day, 20-day or any other period of moving average.

1. Average share prices 2. Moving averages 3. Weighted moving averages 4. Where to plot moving averages 5. Interpreting moving averages - the basics 6. Classic interpretation of moving averages 7. Combining short and long term moving averages 8. Moving average convergence/divergence (MACD) 9. Reversal patterns 10. Head and shoulders top 11. Head and shoulders bottom 12. Double top 13. Double bottom 14. Rounding tops and bottoms 15. Broadening formations 16. Wedge formations 17. The momentum indicator 18. The momentum oscillator 19. Rate of change indicator 20. Price minus average 21. Relative strength indicator 22. Conclusion

• Martin Pring's Introduction to Technical Analysis
• Technical Analysis Plain and Simple
• Technical Analysis of the Financial Markets
• An Introduction to Technical Analysis - Reuters Financial Training Series