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In the last lesson we discussed continuation patterns, in the current lesson we are to enter mechanical technical analysis and more particularly moving averages.

The moving average is one of the most widely used technical indicators. It identifies if a new trend has begun or if an old trend has ended or reversed. It tracks the progress of a trend.

It is the average for a certain body of data. For example, if a 10-day average of closing prices is desired, the closing prices for the last 10 days are added up and the total is divided by 10. The body of data to be averaged moves forwards with each new day and hence, the term ‘moving’.

By averaging the price data, a smoother line is produced, making it much easier to view the underlying trend. A short-term moving average would hug the action price more closely than a longer-term one. The greater the number of time periods used the greater the smoothing.

There are 3 types of Moving Averages:

• Simple Moving Average (SMA)
• Linearly Weighted Moving Average (WMA)
• Exponentially Smoothed Moving Average (EMA)

Please note that the moving average is a follower not a leader. It follows the market and signals that a trend has begun, but only after that happened.

There are two ways to use a moving average. A trader could be using the one moving average and when the market closes above the moving average, this is a bullish sign. When it closes below the MA, we have a bearish sign. Or a trader could be using two moving averages for an even smoother view and when the short-term average crossed above the long-term average, a bullish trend has begun. When the short-term average crosses below the long-term one, a bearish trend is in place.

In the next lesson we are to discuss the Bollinger bands