BALTIMORE (Stockpickr) -- In the world of technical analysis, the moving average, or MA, may well be the most popular indicator out there. But all too often, nascent market technicians only have a passing understanding of the message those added lines on their technical charts are telling them.Today, we're taking a look at how moving averages work -- and how they can signal trades in the real world. Moving averages are hardly relegated to the world of trading. In fact, it's a common statistical tool that's used to interpret large time series datasets by making piecemeal data points relatable to the whole; mathematically, moving averages are smoothing operations that even out statistical outliers and give a clearer picture about the dataset that's being looked at. What that essentially means is that moving averages can take a potentially volatile item like a stock price, and give investors a graph that's much more indicative of the stock's overall movement. MAs cut through the noise of the market. Related: Understanding Candlestick Charts To put it simply, the moving average is just a rolling average - that is, it's the average price of a stock over a given number of days. Every day, the most recent day's data gets added to the moving average and the last day's data falls off. Moving Average Weighting Woes But technicians soon discovered a major flaw in this simple moving average (SMA): weighting. After all, price data from nearly a year ago (in the case of the ever-popular 200-day moving average) wasn't as relevant to today's market as yesterday's price; but both had an equal impact on the value of the moving average. To remedy that, the exponential moving average, or EMA, became a popular alternative. Unlike the simple moving average, where each day's prices held the same impact, the EMA is calculated such that each day's significance decreases exponentially. While other weighting schemes exist, the SMA and EMA are by far the most popular in use by technical analysts today. The time period of the moving average is also a crucial element. The most popular alternatives include the 9-day, 50-day, and 200-day moving averages (simple or exponential, depending on the application as well as the trader's preference). But while daily moving averages, which represent a stock's price over the trailing X days, are common, it's essential to remember that moving averages can be used for any timeframe.
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