Lagging indicator: A lagging indicator is a financial sign that becomes apparent only after a large shift has taken place. Therefore, lagging indicators confirm long-term trends, but they do not predict them. Looking at lagging indicators is one way to confirm whether a shift in the economy has actually occurred. Moving average is a lagging indicator.
Moving Average: It is a trend following indicator and is used to identify changes in trend. A moving average is a way of calculating the average price in a given time frame. It is used in a trending market(price is moving in one direction) and is ineffective in a ranging market ( price is moving in both directions i.e. up and down). So we should use this indicator when the market is trending. It's better to use moving average indicators in conjunction with other indicators.
The disadvantage of moving averages is that they are lagging indicators i.e. they signal late but this disadvantage is overthrown by its advantages.
Moving average comes by averaging the price of the stock in a time span. In order to reduce lag in the simple moving average technique, we use exponential moving average because exponential moving average reacts quickly to recent price changes.
Simple moving averages are used when time frames are big (weekly or monthly) but if we are using a small time frame(hourly,15min). The popular moving average is the 200-day moving average.
It is said that bulls live above 200 moving day average and bears live below 200 moving day average. So moving average also tells about resistance and support zone. Above 200 days moving average trend is bullish and below 200 moving days, the average trend is bearish.
Which moving average to use?
For long term investors: 200,100, 50 day moving average
For positional investor: 50,21,14 day period
For Intraday trader: 14/20,7/10,3/5 period
We can use moving average crossovers to know exit and entry signal.
When the lesser day moving average crosses above the greater value moving average buy signal is generated.
When lesser day moving average crosses down the greater value moving average sell signal is generated.
Here lesser day moving average (14) crosses below the greater value moving average(50) so the signal is sell. ( Here green line represents EMA(50 i.e greater value moving average) and the orange line represents EMA(14 i.e lesser value moving average)).
NOTE: Use moving averages when the market is in trend either uptrend or downtrend.
Now we will learn how to use moving average crossover.
Here at point 1 and 2 , EMA 14 is above EMA 21 and 50 which means buy signal and in point 3 EMA 14 is below EMA 21 which means sell signal.
Here we can see that in an uptrend EMA 21/50 is acting as a support level and in a downtrend, it is acting as resistance.
NOTE: This indication of buy and sell signal is based on only one indicator: Moving Average. It is important to use a certain set of indicators ( both lagging and leading indicators) to predict the correct nature of the market.