How to Trade Using Moving Averages
Moving averages is one of the most common indicators used in cryptocurrency trading. However, it is not uncommon for novice traders to make fatal mistakes when using this tool in technical analysis.
This article walks you through the basics of how to trade using moving averages. We will explore different types of moving averages, the best moving average to use, and the best period setting.
First, what are Moving Averages?
Just as the name suggests, with this indicator, the averages “move” with each price period, thus revealing to traders what the general market bias is. Traders also use it to identify dynamic support and resistance levels from which they buy dips and sell spikes.
There are four major types of moving averages:
- The simple moving average
- The exponential moving average
- Linear weighted moving average
- Smoothed moving average
In this post, we will focus on the simple and exponential moving average. We chose these two because of their self-fulfilling prophecy; price movements often follow them, so most traders tend to act on their signal.
The Simple Moving Average (SMA)
This moving average shows the mean of the close prices for the period considered. All prices are, therefore, equal in value. For example, if you have an eight-day moving average, you calculate the sum of eight close prices and then divide the total by eight. The oldest closing price is eliminated as soon as a new close forms.
The Exponential Moving Average (EMA)
The exponential moving average calculates the highest price with the highest coefficient. Consequently, the EMA is a reflection of which prices move the most, and they give signals faster.
Should you Use SMA or EMA?
This question is a catch twenty-two for most traders. There is minimal difference between the two averages, but your choice can affect your trading. Let’s delve into what you need to know so you can make an informed decision.
Differences between the EMA and SMA
The main difference between the SMA and EMA is their speed. The EMA usually moves faster than the SMA and tends to change direction earlier than the SMA.
The EMA puts more value on the latest price action. This means that EMA can detect changes prices earlier than the SMA would.
Advantages and disadvantages of EMA and SMA
There is no moving average that is better than the rest.
The biggest pro of the exponential moving average is its speed. However, this is also its con. Although it's great to detect changes earlier on, it is also likely that the change is an early signal.
The simple moving average is not very fast in detecting changes, but it can save you from making erratic decisions due to an inaccurate signal. This also means that the SMA will get you into trades later than the EMA would.
At the end of the day, it is up to you to choose which moving average you want to use.
Which is the Best Period Setting to Use?
After you have settled on the moving average you want to use, your next step is to select the best trading period.
For you to determine which type of moving average is best for you, you have to decide on whether you are going to be a day trader or a swing trader.
The period setting of an indicator tells it how many days, hours or minutes of prices to take into account. If you're trading on the 1-hour charts with a period of 21, that means the last 21 hours of prices will be used.
The best moving average for day traders
Short-term traders should go for a moving average that will react quickly to changes in price. You should, therefore, work with the EMA.
As for the period and the length, you should consider using the following:
- 9 or 10 period - this period is not only popular but also fast-moving. It often serves as a directional filter.
- 21 period (medium length) - this medium-term period is the most accurate.
- 50 period - this is a long term moving average. It best used to determine the long term direction.
The best period for swing trading
Swing traders mostly trade on the highest time frames. They also hold trades for more extended periods.
Swing traders should, therefore, use a simple moving average together with higher period moving averages for more accuracy.
Let's look at some of the moving averages that are important for swing traders.
- 20 or 21 period - this period is excellent for predicting trend shifts and it well respected by price.
- 50 period - this is the standard swing trading MA. It is used to ride trend breaks because it is the perfect compromise between short and long term.
- 100 period - this period is suitable for support and resistance trading.
How to Trade Using Moving Averages
Trend and market phase identification
Moving averages come in handy for filtering out price trends from the erratic movements of the market. Newbie cryptocurrency traders find moving averages useful for gauging the overall direction of the market. From a practical point of view, for us to know which market phase we are in, we need to have a fast moving average and a slow one.
Gauge the strength of a trend
Moving averages can also help us determine how strong the trend is. We know that the trend is strong when we see long, short, and medium averages start to diverge in the same direction. Conversely, if these averages are going in different directions, they might be signifying a weak trend.
Dynamic price action
Moving averages can also serve as support and resistance zones; they're capable of halting a price. As such, cryptocurrency prices tend to rebound around these zones.
Triggers for executing new trades
This, perhaps, is the most essential use of moving averages. Look for an opportunity to execute a trade when the following crosses happen:
- A moving average crosses with its smoothed version:
- Price and moving average cross:
- Two or more moving averages cross:
The price and moving average cross is the most crucial trigger of the three because it represents a price action validation about a change in the underlying trend. The other two are only used to confirm that a change has indeed happened.
It is also important to note that the exact point of entry into the market will vary from one trader to another depending on their trading plan. Whichever trading plan you use, at least make sure it’s based on statistical backtesting of a proven strategy.
By now you'll have come to understand that moving averages are a multi-faceted tool that you can use in several ways. Once you understand the underlying basics of SMA and EMA and how to correctly use them, you'll have found a powerful crypto trading analysis tool.
Feel free to share your thoughts on how to trade using moving averages in the comments section below!
Want to learn more? Here are some other articles you might like:
Learn how to read different candlesticks (Beginners)
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About the author:
Jay Jackson is a blockchain enthusiast and a freelance writer at topcryptowriter.com. He works closely with brands (people, businesses and startups) in the crypto sphere. He currently writes Blog posts, Guides, Press releases, ICO reviews, eBooks & Whitepapers. You can find him on LinkedIn.
The above references an opinion and is for informational purposes only. Do not take this as personalised financial or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.
Last updated: 22/08/2019