What is the moving average?

Very present in technical analysis and indicator par excellence for trend monitoring, moving averages make it possible to gauge the current trend and measure its extent.

There are different types of moving averages, the main ones being the simple moving average and the exponential moving average.

The Simple Moving Average (SMA) is equal to the sum of all closing prices for the period studied, divided by the number of periods studied.

For example, a 20-day moving average will be equal to the sum of the last 20 daily closing prices divided by 20.

This average is often criticized for giving equal weight to each price, which makes it unresponsive: many position entries and exits are made too late with this indicator, which is why exponential moving averages are often preferred.

The Exponential Moving Average (EMA), on the other hand, gives more importance to recent prices than to older prices. It is, therefore, more responsive and gives better signals for buying and selling but will also give more false signals.

 

Simple or Exponential Average?

The choice of the moving average you want to use depends on the type of trading you do.

For swing trading / longer-term investment, a simple moving average is sufficient, while for more responsive trading (day trading / scalping), the exponential moving average will be preferred because it will stick better to the prices because of its calculation which gives more importance in the weighting to the last recorded prices.

Generally, daily moving averages 20, 50, 100 and 200 are the most used:

  • 20 for a short-term trend
  • 50 for a short to medium term trend
  • 100 for a medium/long term trend
  • 200 for a long-term trend

Trading strategy on moving averages

There are different ways to trade moving averages. The simplest strategy is to enter or exit positions when prices cross the moving average up or down. Some prefer to use moving averages from different periods and buy / sell when the averages cross each other.

 

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Example of a trading strategy: a sale was possible on BTC when the 20-day moving average (white) crossed the 50-day moving average (purple).

 

The problem of moving averages

Moving averages are useful for judging a trend, but you should not use them in your trading strategy. Indeed, the signals given by these are often late and if it were enough to buy / sell on a simple crossing of these lines, it would be known!

 

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Example of a cross between the MA20 day and the MA50 day: possible purchase. But as usual, the signal was late, and the trade lost.

 

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Example of a simple moving average of 50 periods (purple) and an exponential moving average of 50 periods (white). On large time units (here as a daily), the two are very close.

 

It is generally accepted that the most aggressive and dynamic traders prefer exponential moving averages which, as seen in this example, generally stick more to prices, while simple moving averages are often preferred to judge the general strength of a movement and the dynamics in progress.

Once again, you will need to test what is best for your kind of trading.


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