What is Daily Moving Averages and How It Helps?

By Angel Broking | Published on 5th May 2020 | 269

What is Daily Moving Averages and how it helps

The stock market witnessed a broad-based sell-off due to the impact of the Covid-19 pandemic on the economy. Even then, the number of new demat accounts surged by record numbers. Trading volumes on the National Stock Exchange jumped 53% in April as markets recouped some losses from March lows. Over 1.2 million new demat accounts were opened just with the Central Depository Services in March and April as compared to 4.2 million in the 11 months to February. The latest data from NSDL is not available.

It can be safely presumed that a large number of new participants are traders as a volatile market is more suited for short-term traders than long-term investors. A number of technical tools are used by traders to ascertain the trend and invest accordingly. The moving average is one of the most dynamic and popular technical tools used by traders.

What is DMA?

A daily moving average is a widely-used tool but one needs to have a clear knowledge of its application. The daily moving average shows the arithmetical mean of the daily prices over a period of time. Let us take into consideration the number of variables associated with stock prices to understand the use of DMA. A stock price opens at a different level, touches a high and a low during a day and may close at another price level. These levels change every day, which results in a lot of data points. It is not possible for every trader to analyse every data point and make decisions. Daily moving averages remove the noise from price movements over a period and give a clear picture of the price trend to the trader.

To calculate moving average, one just needs to take the closing prices of a stock for any given interval and divide it by the period. For instance, if you want to get the 50-day moving average, add the closing price of the stock for the first 50 days and divide it by 50 and plot the value along with the closing price on the fiftieth day. It will provide you the 50-day moving average, but moving averages are dynamic tools and the latest data has to be integrated to keep it relevant. On the 51st day, you will have to remove the data of the first day and add the data from the 51st day. The process has to be repeated with each passing day.

Different types of daily moving averages and their uses

Moving averages are an efficient tool for getting the price trends of stocks without the accompanying noise. The need for different moving averages arises as traders have varying requirements. For instance, a 200-day moving average may not be of much relevance for an intraday trader who has to compulsorily square off his/her positions before the market closes. He/she will find the moving average of 10 minutes or an hour more helpful. One should use moving averages according to his/her investment horizon. Some of the popular moving averages are the 7-day moving average, 10-day moving average, 30-day moving average, 50-day moving average and 200-day moving average.

Daily moving averages of longer tenure give the additional advantage of removing the discrepancy in price trends due to a one-off incident. A stock price may decline or rise significantly due to a one-off development. If you take a 7-day moving average or a 10-day moving average, the impact of the development may distort the price trend and may lead to trading errors. A longer-term moving average like the 200-day moving average will provide a better picture in such situations. The different daily moving averages give the same information, but for different time periods. The 200-day moving average provides long term price trends, the 100-day moving average or the 50-day moving average provide the mid-term trends, while the 30-day moving average and the 10-day moving average give the short-term trend.

Conclusion

Daily moving averages have become a common tool used by traders and investors alike. All the stockbrokers provide the chart for moving averages as a part of the package with the trading account. But investors and traders should use the appropriate daily moving average to get the desired results. Investors with advanced knowledge can use the combination of two moving averages or the exponential moving average. These are more advanced types of moving averages and should only be used after mastering simple moving averages.