My problem with using moving averages

One of the first things that traders learn when they are starting off is the technique of using moving averages. The statistical definition of one is “a succession of averages derived from successive segments (typically of constant size and overlapping) of a series of values.” Now, these are good if the price is remaining at about the same level over a period of time, but what if a stock is appreciating or depreciating rapidly?

The data that moving averages are based on is entirely from the past, and, as they say, you can’t predict what direction the market will go in. Yes, maybe it’s been bullish over the past month, but tell me about now. When a stock is volatile, moving averages serve little to no function, as a small spike in any direction can result in huge losses, and what past trends were does not affect that.

It does not take into account significant changes in supply and demand. A great example of this would be the price of crude oil. Great, you’ve used a moving average for when it was at $100/barrel, but how is that going to help you when supply has skyrocketed and the price has fallen to $50/barrel?

Even if a stock has been at the same level for a long time, how will moving averages help you then? There would just be a horizontal line. You could say that you should buy when the price goes above the moving averages, but stocks often exhibit cyclical behaviour, and the stock is just as likely to plummet as it is to skyrocket.

All in all, because of these reasons, I don’t believe that moving averages are a very effective tool, as all they are based on is past data and they just don’t work for volatile stocks.

By Shrey Srivastava

A finance and economics enthusiast, and someone who wants to share his views with the world.

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