Moving averages are the most common indicator used by the traders to trace and predict the trends an asset, a stock, or a cryptocurrency is going to follow in the future. Moving averages are calculated by averaging the price of an asset over a specific period of time. The specific period depends upon the trader’s requirements and the extent to which the trader wishes to track back the prices. If you are a shorter-term trader, a shorter moving average will be more effective for your trading style. However, if you are a longer-term trader or investor, you’ll likely do better with a long moving average. Moving Averages help you to ignore the noise and focus on direct trading decisions. It is a lagging indicator that smooth action over a period of time to help you track the crypto’s potential price.
The moving average is calculated by adding together the closing price of an asset over the number of days you’d like to plot a trend line for. You would then divide that number by the number of days you have marked on your trend line.
You don’t need to draw moving averages, but you need to decide the timeframe. The indicator draws a trendline and you can track the variation current prices are showing compared to the averaged. The prices are expected to reduce this difference and come closer to the prices denoted by the trendline. You can also use the MA to help establish support and resistance lines.
There are two types of moving averages. The first is the traditional moving average, which is often referred to as a simple moving average. Second is the exponential moving average, which is a weighted moving average that gives more weight to recent prices.
SIMPLE MOVING AVERAGES
The moving average we discussed above is an example of Simple Moving Average. Simply put, a simple moving average is calculated by adding up the last “X” period’s closing prices and then dividing that number by X. The most common simple moving averages that you’ll read about are the 50, 100, and 200 day moving averages. Each of these three moving averages will show the momentum during their respective time period (50 days, 100 days, or 200 days).
One of the drawbacks of using SMA is it can produce inaccurate results. Since the data points are assigned the same weight, which affects the outcome of each one equally. This means if you have a price that is severely out of range, compared to the other price points, this can skew the simple moving average line.
EXPONENTIAL MOVING AVERAGES
Also known as EMA, Exponential Moving Averages includes an exponential multiplier which is calculated by a rather complex equation. Due to this multiplier, EMA reacts faster to the price changes. This makes EMAs much faster than simple moving averages (SMA) and will give you a rather quick indication as to when to enter or exit a trade.
WEIGHTED MOVING AVERAGE
Weighted Moving Average (WMA) gives more weightage to the recent data and lesser to the old data. WMA will follow prices more closely than a corresponding Simple Moving Average. This is done by multiplying each bar’s price by a weighting factor.
Key points to remember:
- A moving average is expected to act as a form of support and resistance. As with most indicators, the longer the time frame you are using, the stronger the support or resistance.
- It’s very simple. If a moving average is sloping upwards, this supports the fact that the asset is in an uptrend.
- Similarly, if the moving average is sloping downwards, it’s probable that the asset you’re assessing is in a downtrend.
- You can draw 2 Moving averages of a short and a long time frame and track the crosses. Once you’ve got a short-term MA and a long-term MA switched on, watch out for crosses. This cross is also called as the golden cross. Here’s what they mean:
- Short MA crosses above long MA: bullish trading signal
- Short MA falls below long MA: bearish trading signal