Moving averages (MA) are essential technical analysis tools that smooth out price fluctuations over time, providing a clearer picture of market trends. They are often referred to as “sliding averages” and play a crucial role in identifying and confirming trends. The adage “trend is your friend” highlights the importance of aligning trades with the prevailing market direction for better success rates and reduced losses. Below is a visualization of how moving averages appear on a chart.
Table Content:
- Calculating Moving Averages
- Common Moving Averages
- Interpreting Moving Averages
- Advantages and Disadvantages of MAs
- Understanding Exponential Moving Averages (EMA)
- Interpreting EMAs
- Common Exponential Moving Averages
- Advantages and Disadvantages of EMAs
- Adding Moving Averages on TradingView
- Utilizing Moving Averages in Trading
- Favoring EMAs over SMAs
- Three EMA Trading Strategies
Moving Averages on a Chart
The Simple Moving Average (SMA) is the most basic type of moving average and is often used interchangeably with the term “MA.”
Calculating Moving Averages
A moving average is calculated by summing the closing prices of a specified number of trading periods and then dividing by that number.
Example: A 10-period moving average (MA10) is calculated by adding the closing prices of the last 10 trading periods (on a candlestick chart, this corresponds to the closing prices of the last 10 candles) and dividing the sum by 10.
The general formula is as follows:
Most charting software and platforms like TradingView automatically calculate moving averages, so manual calculations are not typically required.
Common Moving Averages
- Short-term (fast) MAs: MA10, MA20
- Medium-term (slower) MAs: MA50
- Long-term (slowest) MAs: MA100, MA200, MA730
Interpreting Moving Averages
Period-Based Interpretation:
- Shorter-period MAs: React quickly to price changes and closely follow current price action.
- Longer-period MAs: React more slowly and are less sensitive to short-term fluctuations.
Trend-Based Interpretation:
- Uptrend: Price typically stays above the MAs.
- Downtrend: Price typically stays below the MAs.
Dynamic Support and Resistance:
MAs also act as dynamic support and resistance levels.
- Uptrend: Price often retraces to short-term MAs before continuing upwards.
- Downtrend: Price often retraces to short-term MAs before continuing downwards.
The chart above illustrates Bitcoin’s price action during a strong uptrend. The price repeatedly retraces to the MAs before resuming its upward trajectory. In an uptrend, the MA acts as support; after a retracement to this level, the price often continues to rise due to increased buying demand.
Advantages and Disadvantages of MAs
Advantages: MAs filter out short-term noise, providing greater reliability for long-term trading. They are particularly useful on larger timeframes.
Disadvantages: MAs can lag behind price action, making them less responsive to rapid changes in smaller timeframes. This lag can impact short-term traders who rely on quick entries and exits, such as scalpers.
Understanding Exponential Moving Averages (EMA)
The Exponential Moving Average (EMA) gives more weight to recent price data, making it more responsive to new information. It differs from the SMA in several key ways:
- Greater weighting assigned to recent price changes.
- Closer adherence to recent price action than the SMA.
- Faster reaction to price fluctuations and potential reversals.
Interpreting EMAs
Period-Based Interpretation:
- Shorter-period EMAs: React quickly and closely follow current price action.
- Longer-period EMAs: React more slowly and are less sensitive to short-term fluctuations.
Trend-Based Interpretation:
- Uptrend: Price typically stays above the EMAs.
- Downtrend: Price typically stays below the EMAs.
Dynamic Support and Resistance:
Similar to SMAs, EMAs act as dynamic support and resistance levels.
- Uptrend: Price often retraces to short-term EMAs before continuing upwards.
- Downtrend: Price often retraces to short-term EMAs before continuing downwards.
Referring back to the Bitcoin chart, the price interacts with the EMAs more frequently than the SMAs. This provides more potential entry points for short-term traders.
Common Exponential Moving Averages
- Short-term (fast) EMAs: EMA10, EMA21
- Medium-term (slower) EMAs: EMA50
- Long-term (slowest) EMAs: EMA100, EMA200
Advantages and Disadvantages of EMAs
Advantages: EMAs offer greater responsiveness to market movements, allowing for quicker identification of potential trend changes and reversals. They are well-suited for short-term trading and scalping strategies.
Disadvantages: Due to their sensitivity, EMAs can generate false signals. Discipline and the use of stop-loss orders are crucial to mitigate risk.
Adding Moving Averages on TradingView
Step 1: Open a chart for any cryptocurrency and click the “fx” icon.
Step 2: Search for “Moving Average.” Both EMA and SMA options will appear. Select the desired moving average type.
Step 3: By default, the chart will display either EMA9 or MA9. To change the period, hover over the MA line, click on the settings icon.
Step 4: Enter the desired period in the input field and click “Ok.”
Utilizing Moving Averages in Trading
Favoring EMAs over SMAs
While SMAs are well-established in traditional markets, EMAs are generally preferred in the faster-paced cryptocurrency market due to their responsiveness. SMAs can be suitable for spot trading, but EMAs are often more effective for margin trading with leverage.
Three EMA Trading Strategies
1. Trend Following:
- Price above EMA: Confirms an uptrend; consider long positions.
- Price below EMA: Confirms a downtrend; consider short positions.
- EMA crossing price sideways: Suggests a sideways market; wait for clearer confirmation before entering a trade.
Using the EMA200 on the daily (D1) timeframe is a reliable way to identify long-term trends. Remember, MAs are lagging indicators, so the market often moves before the MA confirms the trend.
2. Dynamic Support and Resistance:
Utilize EMAs as dynamic support and resistance levels by:
- Entering trades in the direction of the trend after a price retracement to the EMA.
- Waiting for a confirmed EMA breakout and subsequent retest before entering a trade in the direction of the new trend.
3. Combining with Other Indicators:
Moving averages are not the only technical indicators available. Incorporating trendlines, volume, RSI, and other indicators can provide further confirmation and filter out noise.
In the example above, C98 is moving within a triangle pattern and is below the EMA20. A trader with a long position entered near the lower boundary of the triangle could consider taking profit at the intersection of the upper boundary and the EMA20, as this point represents a confluence of resistance.
Predicting price movements in financial markets is complex and requires experience. Moving averages are valuable tools when integrated into a well-defined trading system.
