The moving average is one of the oldest tools used by technical analysts. Daily fluctuations in stock prices, commodity prices, and foreign exchange rates can be large. Moving averages tone down these fluctuations— deemphasizing but sometimes distorting fluctuations. Technical analysts use moving averages to smooth erratic data, making it easier to view the true underlying trend.
The principal reason that moving averages are used is to smooth out shorter fluctuations and focus on the trend that fits with the investor’s time horizon. A moving average by its nature is just one number that represents a net of certain past numbers. For example, a 20-day moving average is one number that represents all the prices for the past 20 days. As such, it filters out each one of the prices during the past 20 days and tells us how the group of 20 days, rather than its separate parts, is behaving.
Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.
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