Technical analysis uncovered: How to use moving averages to your advantage
Technical analysis is all down to looking at a share's price action to work out what to do next. One of the most commonly used indicators is the moving average. But how can you use it to your advantage? Read on to find out more…
The “moving average” is an example of a useful technical analysis indicator, Dr Steve Sjuggerud in Investment U
While shares fluctuate wildly over days and weeks, looking at the movement of the average over a period of time can smooth out the fluctuations. This lets you grasp the underlying trend.
More importantly, moving averages can be a great way to significantly decrease your risk and slightly improve your returns.
Jeremy Siegel, author of Stocks for the Long Run and a noted Finance Professor at the University of Pennsylvania, broke with the tradition of academics and actually tested a simple technical analysis rule himself. He looked at the 200-day moving average.
During his test, when a share’s price moved above its 200-day average, Siegel bought. And if a stock dipped below its 200-day average, he sold.
Siegel’s conclusions on moving averages
What Siegel found is that from 1886 to 2001, using the 200-day moving average as your indicator, you would have earned 2% points better than someone using a “buy and hold” strategy. And you would have done so with significantly less risk. You were only in the market about two-thirds of the time.
So there you have it, how to use moving averages to your advantage.