A moving average is a way of averaging the price. The outcome derived -- a smooth line --provides information on the direction of the market.

There are two types of moving averages. A simple moving average obtained over a period of, let's say 20 days, is obtained by adding the market value of 20 days and dividing the outcome by 20. The following week, the new week is added, and the first week is dropped out of the average. The total obtained is once again divided by 20.

Moving averages tend to lag the action of the market. This is the "price" that investors have to pay for the smoothing effect of the moving average. The use of moving averages is twofold. The first important use is as a visual aid for determining the trend of the market.

The second important use of a moving average comes into play when the actual value of the market falls below the value of the moving average. This is an important signal that should not be taken lightly -- especially if the moving average is over a period of 50 weeks. In fact, a rule of thumb is that the longer the periods used for the moving average, the more important the signal when the market falls either below or above the moving average.

For instance, if we use a 50-week moving average, and the market falls below the 500-week moving average, the signal is very important and should be taken as a serious warning that the trend in the market is changing in a significant way. On the other hand, the violation of the downside or the upside of a 10-day moving average is not as important as a violation of a 50-week moving average.

The risk with these kinds of timing techniques is that investors could be "whipsawed". The term whipsaw refers to the fact that, for instance, the market falls below the moving average, thus giving a sell signal and suddenly reverses itself, and after a few days or a few weeks, moves above the moving average again, providing a buy signal. There are no simple or reliable rules in the investment arena. Each signal may or may not be important. It has to be put into context with all the rest of the information the investor is following.

Several websites and software applications provide stock market charts and stock charts with moving averages where the user can choose the moving average span. The most frequently used moving average is over 40 or 50 weeks, and when using daily charts, the 10 or 25 days moving average is also widely used.

Moving Averages Crossovers
When one computes a 20-week moving average and then computes a 50-week moving average, the 20-week moving average moves more rapidly with the market than the 50-week. The use of a fast- and a slow-moving average can provide further information on the action of the market. The investor can obtain an oscillator, which is an indicator that moves around zero by taking the difference of the two moving averages. This indicator provides a buy signal when the oscillator rises above zero and a sell signal when it falls below zero. This methodology has been called a moving average convergence-divergence indicator.

The indicator that uses the moving average crossover technique is called the MACD oscillator. This oscillator uses two exponential moving averages: One short-term and one long-term.  Use of  this system would have identified that the market pattern  had changed by April 2009.