Your Money: A few technical indicators that can help identify market trends
September 22, 2020 5:10 AM
Trend analysis of stock price movements using some useful technical indicators can help gauge the overall direction in which prices are moving, and how they may behave in future.
The MA indicators are lagging indicators and should be used only to confirm a trend or trend reversal.
By Hemanth Gorur
Stock markets are known to be brutal to investors who invest unscientifically or based on hearsay. While no one can predict stock price movements with certainty, it helps to take an educated guess or informed decision before investing.
Technical analysis of stock prices enables investors to do just that. Trend analysis of stock price movements using some useful technical indicators can help gauge the overall direction in which prices are moving, and how they may behave in future.Let us look at some simple but powerful technical indicators.
Simple Moving Average (SMA) A single price point contains almost no information useful for investing. On the other hand, when you take a series of consecutive price points and take their average, you get a composite data point. This is called a Simple Average. For example, the average of a stock’s price points on ten consecutive trading days is a 10-day Simple Average of the stock price.
When you successively determine the Simple Averages by including the most recent price point and excluding the oldest price point, you get a Moving Average (MA). For example, you can calculate the 10-day Simple Average of stock prices on Day 1 to Day 10, followed by the 10-day Simple Average of Day 2 to Day 11, and so on. This gives you a series of 10-day Simple Averages, which when joined together, gives you a 10-day Simple Moving Average (SMA) trend line of the stock price. As daily stock prices are usually volatile, SMAs help to smoothen the curve and determine the overall trend or direction of the stock price movement.
Exponential Moving Average (EMA) The Exponential Moving Average (EMA) is similar to the SMA but allocates weightages to each price point, with more recent price points getting higher weightage, unlike the SMA which allocates equal weightage to all price points.
The formula for EMA is: EMA = Current stock price x Multiplier + EMA of previous day x (1 – Multiplier). The Multiplier can be calculated as: Multiplier = 2 / (Number of price points + 1)
EMA will be more sensitive to recent price movements than earlier ones. Due to this, an EMA will “hug” the price movements more closely than an SMA. Some of the popular MAs are the 10-day, 12-day, 20-day, and 26-day MAs for short term trends, and the 50-day, 100-day, and 200-day MAs for long term trends.
Support Levels, Resistance Levels Both SMA and EMA can be used as “support” or “resistance” trend lines. When the stock price is on an uptrend, it tends to “bounce” off certain price levels that coincide with an MA trend line. That is, the price refuses to drop below the MA. This is called a Support Level. This can be an interim entry point for buying into the stock, assuming the uptrend will sustain over your investment horizon. However, if price movements start breaking through the Support Level, it can indicate a trend reversal and investors can consider exiting the market.
Similarly, during a downtrend, as the stock price moves towards the MA trend line, it can bounce down after “hitting” the MA trend line. This can be the exit point for investors planning to sell some of their stock to take advantage of a temporary high in the stock price during a downtrend. However, if price movements start breaching the Resistance Level, this can indicate a trend reversal and investors can look to enter the market.
The MA indicators are lagging indicators and should be used only to confirm a trend or trend reversal. However, entry or exit point for the investor into or from the market usually precedes a trend confirmation or reversal as indicated by an MA.