- Moving averages are one of the most important tools in a trader’s arsenal
- Moving averages can help identify the directional momentum of an asset
- They can be used to show when an asset has ‘turned a corner’
FullyCrypto’s Trading 101 series looks at the basic tools and signals you need to know in order to trade profitably. By using them in conjunction with each other, and factoring in other indicators such as fundamental news, you can start to trade any asset or commodity, not just crypto.
What Are Moving Averages?
A moving average (MA) is an indicator used to analyze a trend and filter out the short-term fluctuations in price. It is what’s known as a ‘lagging indicator’ because it is based on past prices. The two most commonly used moving averages are the simple moving average (SMA) and the exponential moving average (EMA):
- SMA – the simple average of an asset over a defined number of time periods
- EMA – an average produced with greater weight and significance on the more recent data points
MAs are most commonly used to identify a trend direction and to determine support and resistance levels. Moving averages are useful enough on their own, but they also form the basis for other technical indicators such as the Moving Average Convergence Divergence (MACD).
What Do MAs Look Like?
Moving averages are based on past price action to indicate a trend, and you can set the length to assess the trend over a number of time periods, with a longer time period resulting in greater lag. For example, a 200-day MA has a much greater degree of lag than a 50-week MA because it contains prices for the past 200 days, but it helps identify a longer term trend.
The length of the moving average mirrors the trading nature, with shorter time frames used for short-term traders and longer-term timeframes more suited for long-term investors. We use these examples because the 50-day and 200-day MAs are widely followed by investors and traders, with breaks above and below this moving average considered to be important trading signals.
These are indicated in the below Bitcoin chart by the orange line (50-day) and the 200-day (purple line):
As you can see, the crossing of the lines reflects a change of trend, which is particularly evident with the ‘golden cross’ which is when the 50-day and 100-day cross, indicating a potential trend reversal. Bitcoin experienced a golden cross in early March (the turquoise line crossing the orange line above) which precipitated a sharp price rise.
Of course, MAs cannot predict price action, but as you can see they can offer a good insight into potential medium and long term changes in direction. An example of this in reverse is when Bitcoin came off the back of its $20,000 all time high in December 2017:
As we can see, MAs on their own couldn’t possibly predict the sharp decline in January, but when the trend hadn’t reversed by mid-February the lines crossed over and many realized that a longer term decline was on the cards. Sure enough we experienced Bitcoin’s longest evert bear market.
A Powerful Tool
Moving averages are a powerful trend indicator that all traders, both short and long term, should use to analyse the current trend and blend with other indicators to shape their future moves. We’ll go more into these other indicators in later editions of Trading 101, so stay tuned!