Nearly all major market indexes, counting the Dow, have now exceeded their 200-day moving averages, says stockcharts.com. It's considered a positive sign for the stock market, and backs up the theory that rock bottom is something we've already seen.
But what is a moving average? Why not simply use a single day stock chart to measure financial gain or loss?
"Moving averages are one of the most popular and easy to use tools available to the technical analyst," says the stockcharts.com chart school. "They smooth a data series and make it easier to spot trends, something that is especially helpful in volatile markets. They also form the building blocks for many other technical indicators and overlays."
A simple moving average is calculated by computing the average (mean) price of a security over a specified periods of time. Although it is possible to make moving averages from the Open, the High, and the Low data points, most moving averages are made using the closing price.
There are three main uses for moving average calculations: trend identification and confirmation; support and resistance level identification and confirmation, and for trading systems. As a rule, all moving averages are lagging indicators and will always be "behind" the current price. The price of security x, for example, is trending down, but the simple moving average, based on the last 10 days' worth of data, is still above the price. If the price were on the rise, the SMA would most likely be below its current price. Since moving averages are lagging indicators, they are considered to be in the group of trend following indicators.
Moving averages make it easier to identify the direction of the trend. Moving averages do not show a change in trend, rather pursue the current trend. As a result, they are best used for identifying and following trends, not for predicting trends.
"Because moving averages follow the trend, they work best when a security is trending and are ineffective when a security moves in a trading range," says stockcharts.com. "With this in mind, investors and traders should first identify securities that display some trending characteristics before attempting to analyze with moving averages. This process does not have to be a scientific examination. Usually, a simple visual assessment of the price chart can determine if a security exhibits characteristics of trend."