What are Moving Averages: A Simple Technical Indicator For Beginner Traders

A moving average is a technical indicator that helps smooth out price action by averaging out price fluctuations over a certain time period. It takes a series of past price data points and calculates the average (mean) value of those prices over a specified period.

As new data points are added, the average is recalculated and the old data points are dropped. This means that the moving average is always reflecting the most recent price action as new price data becomes available, hence the name “moving average.”

For example, let’s say we are using a 50-day moving average. This means that we are averaging the closing prices of the stock over the past 50 days. Every day, the 50-day moving average will be recalculated to include the closing price of the current day and drop the closing price from 50 days ago.

There are two main types of moving averages: simple moving averages (SMAs) and exponential moving averages (EMAs).

Simple Moving Averages (SMAs)

SMAs are calculated by taking the average price of a security over a specified number of periods. This type of moving average gives equal weight to each price data point within the specified period.

To calculate the SMA, you add up the closing prices of a set number of periods and then divide by the number of periods. For example, a 10-day SMA considers the last 10 closing prices. A 50-day SMA would take the average price of the security over the past 50 days. The longer the period, the more smoothed out the moving average will be.

Exponential Moving Averages (EMAs)

EMAs are similar to SMAs, but they give more weight to recent prices, making them more responsive to recent price changes. This means EMAs react faster to price movements compared to the SMA. Traders often use EMAs for short-term analysis.

Why Use Moving Averages in Crypto Trading?

The rationale behind using moving averages to time the market (i.e. identify buying and selling prices) is pretty straight-forward.

For example, if the average price of an asset is $100 and the current price is $90, this could be seen as a buying opportunity. This is because the asset is currently below its average price, which suggests that it may be undervalued. Conversely, if the average price of an asset is $100 and the current price is $110, this could be seen as a selling opportunity. This is because the asset is currently above its average price, which suggests that it may be overvalued.

However, in crypto, prices can be highly volatile, with rapid fluctuations that, taken on their own, mean nothing much. Moving averages help smooth out this noise, making it easier to spot trends amidst the volatility.

Of course, the average price is just one factor to consider when making buying or selling decisions. Other factors to consider include the crypto project’s fundamental technology, the overall market conditions, and your own investment goals. However, the average price can be a useful tool for making informed investment decisions.

How to Find Moving Averages on a Price Chart

Moving averages can be found on most trading platforms. It is represented as a continuous line on the price chart, drawn by plotting the average price of the asset over each period and connecting these points to create a smooth curve.

To find an SMA, simply look for the “Moving Average” indicator and select the desired period. For example, to find a 50-day SMA, you would select “SMA” and then “50”.

It will look something like this:

(Source: TradingwithRayner.com)

To find an EMA, you would follow the same steps, but select “EMA” instead of “SMA”.

How to Use Moving Averages to Guide Trading Decisions

1. Entry and exit points: Moving averages can also be used to identify potential entry and exit points (using them in combination with other technical indicators.) For example, you could buy an asset when the price crosses above the moving average, and sell it when the price crosses below the moving average.
2. Identifying trends: Moving averages can be used to identify the direction of the trend. If the price is above the moving average, it is considered to be in an uptrend. If the price is below the moving average, it is considered to be in a downtrend.
3. Identifying reversal of trends: Traders often look for two main signals when using moving averages:

• Golden Cross: This occurs when a short-term moving average (e.g., 50-day EMA) crosses above a longer-term moving average (e.g., 200-day EMA). It’s considered a bullish signal and suggests it might be a good time to buy.
• Death Cross: Conversely, a death cross happens when the short-term moving average crosses below the longer-term moving average. This is a bearish signal and may indicate it’s a good time to sell.

The Bitcoin Golden Cross in blue circle and the Death Cross in red circle. The Golden Cross proved accurate — just 2 months later, Bitcoin hit an ATH of $69,000 (Source: Trading View)

It is important to note that moving averages are lagging indicators, which means that they only reflect past price movements. This means that they cannot predict future price movements with certainty. However, they can be a useful tool for identifying trends, support and resistance levels, and potential entry and exit points.

Difference Between SMA and EMA: Which To Use

Choosing between a Simple Moving Average (SMA) and an Exponential Moving Average (EMA) depends on your trading strategy, objectives, and preferences. Here are some factors to consider when deciding which type of moving average to use:

Additional tips for using moving averages in crypto trading

• Use different moving averages for different trading strategies and horizons. The choice of moving averages and their periods depends on your trading strategy and time frame. Shorter periods (e.g. 10-day or 50-day) are suitable for short-term traders, while longer periods (e.g. 100-day or 200-day) are better for long-term investors.
• Consider the volatility of the asset you are trading. If the asset is highly volatile, you may want to use shorter moving averages.
• Combination with other indicators: Some traders use both SMAs and EMAs in combination with each other or with other technical indicators. For instance, using a longer-term SMA for overall trend identification and a shorter-term EMA for entry and exit signals can provide a well-rounded analysis.
• Look for confluence: To increase the reliability of your support and resistance levels, consider looking for confluence with other technical analysis tools and price patterns. For example:
• Check if a significant support or resistance level identified by moving averages aligns with a horizontal support or resistance level drawn based on historical price data.
• Look for candlestick patterns or other technical indicators that confirm the significance of the identified support or resistance level.

In Conclusion

In summary, moving averages are a valuable tool for beginners in crypto trading to analyze price trends, smooth out volatility, and make informed decisions about when to buy or sell a cryptocurrency based on historical price data. However, it is important to remember that they are not a foolproof method, and should always be used in conjunction with other technical and fundamental analysis tools for a comprehensive trading strategy.