Each trader, regardless of experience and preferences, strives for one goal — to maximize profits from their trades. To achieve this goal requires not only a deep understanding of the market, but also mastery of different technical analysis instruments. One of the most universal and commonly applied tools is the moving average.
At first glance, the concept of moving average may seem simple, but its effectiveness has been confirmed by years of successful use by experienced traders. It is a powerful indicator that allows you to identify trends in the stock market and help you make informed trading solutions.
In this article you will learn about what a moving average represents, its calculation and how to properly utilize this indicator when trading cryptocurrencies and other assets.
What is a moving average and how it works
Moving average represents one of the most widely used and effective indicators of technical analysis. Its task is to smooth out sharp price fluctuations on the chart, while revealing the general trend of the movement of the asset.
The algorithm for calculating the average dynamics is quite simple: we take a certain period of time (for example, the last 10 days), summarize the closing prices for these days and share it by the amount of days in the time period. The obtained value is the desired value of the indicator.
The next day, the calculation is repeated, only for the next 10 days — the oldest value is discarded and the last one is added. Thus, the averaged dynamics seems to «slide» forward on the time scale of the graph.
The longer the period for calculation, the smoother and smoother the indicator curve will be. Short periods are more sensitive to market impulses, but at the same time more «noisy». Experienced traders often use several moving averages with various terms on one chart.
The main task of this indicator is to clearly demonstrate the direction of the current tendency. If the price is higher than the moving average, the tendency is regarded as ascending, while if it is lower, it is regarded as descending. The intersection of the indicator curve and the price chart indicates a potential tendency shift.
Kinds of moving averages
Various types of moving averages exist, each with its own peculiarities of application. Let’s familiarize ourselves with the main types of this indicator.
Simple moving average (SMA)
It is the base and the widest type of indicator. Its value for each period is computed as the arithmetic average of close values for a given number of periods (days, hours, etc.). All prices have the same weight, regardless of its «age».
For example, for a 9-period SMA, the closing prices for the last 9 periods are taken, summed up and divided by 9. For the next period, the oldest price is discarded and the new one is added to the calculation.
The advantages of SMA are simplicity of calculation and visibility. Disadvantage - slow reaction to trend changes due to the equilibrium of all prices.
Exponential moving average (EMA)
In contrast to SMA, this type gives higher values to more recent data of price. That is, the latest prices influence the EMA value more strongly than older ones. This allows the indicator to react faster to trend reversals.
The calculation of EMA is more complex than that of SMA and includes a special smoothing coefficient. The smaller it is, the more «heavy» and inert the EMA will be. High values of the coefficient are used for more sensitive price tracking.
Due to its lower inertia, EMA is preferable to utilize for near-term trading and tracking a dynamic market.
Shifted MA
This is a modification of the simple or exponential type, where the indicator values are shifted a certain number of periods forward or backward relative to the usual location on the chart.
Such a shift allows the indicator to anticipate signals, which increases its predictive properties. However, excessive shifts can lead to a large number of fake alarms.
Weighted moving average (WMA)
In this variety, large amounts of weight are given to recent values, but in contrast to the EMA, it is distributed not exponentially, but linearly. That is, the closer prices are to the current moment, the greater their weight.
Due to the weighting algorithm, WMA reacts to price fluctuations better than SMA, but worse than EMA. It is used mainly for intraday trading, especially in unstable markets.
There are other types of moving averages, such as hybrid ones. Many dealers use various kinds of indicators to build author’s trading systems.
How to apply moving averages?
Moving averages is one of the universal instruments of technical analysis. It can be applied both for short-term trading and long-term investments. Everything depends on the correct setting of the averaging period.
The longer the period, the more «smooth» and inert the moving average line will be on the chart. This allows them to filter brief price swings, but the indicator will react slower to the trend change. That is why long time periods, e.g. 100 or 200 days, are preferable for investors who are oriented on long-term holding of positions.
If you prefer active intraday trading, then short periods of the indicator — 9, 14 or 20 days — are suitable for you. Fast moving indicators react to any price changes, which allows you to quickly enter into deals and fix profits when the trend reverses.
Experienced traders often mix multiple moving averages with various time frames on the same chart. For example, a fast 20-period moving average and a slow 100-period moving average. In this case, crossings of indicator lines form precise signals to open or close positions. And divergences between the price and the moving lines can show the upcoming turn of the trend.
Also, sliding lines are widely used as a filter. Trades are opened only after the price breaks the level of the moving average. This helps to screen out false alarms of different indicators.
The specific choice of the type and parameters of moving averages depends entirely on the trading mode and personal style of the trader. It is important to test different settings on historical data and find the best option for your trading strategy.
