It’s a very popular technical indicator among traders that takes into account the average prices for a given period. It’s a way to smooth out price fluctuations and mitigate noise. Also used to define trends and as a trading signal for buyers and sellers.
The duration, or number of periods, represents the number of candles that will be used in the calculation of the MM. For example, a 30-period moving average involves averaging the last 30 candles on the chart.
Simple vs. Exponential Moving Averages
The most used MA are exponential and simple. The choice is up to the will of each one. If you prefer an indicator that responds more quickly to price changes, te better choise is the exponential moving average. EMA, from Exponential Moving Average, can identify changes in trends more quickly, but precipitation can be harmful and may show false signs of changes in trends.
The SMA, Simple Moving Average, is slower, can filter some of the false signals that the EMA presents. However, the excess of caution can offer a late entry in the trade and leave the entire result of the operation to the market.
Below the comparison of exponential moving averages (EMA) and simple (SMA).
Using MA to define trend
The MA offer several resources for the decision making of traders. One is the trend definition. Observing that prices follow a long way above the moving average, we can say that the asset is in an upward trend. The same goes for the downward trend with prices below the MM line.
A slightly more precise way to define a trend is to use two MA as a parameter. In the example below, the 30-period EMA (fastest) is above the 50-period EMA (slowest). We then say that the asset is in an upward trend.
Moving Average Crossovers
This powerful technical analysis tool can help you determine when a trend is about to end and reverse. The strategy consists simply of crossing two or more moving averages. This may be the first sign that the trend is ending or weakening.
In the example below, the 20-EMA crossed up the 30-EMA showing a buy signal. After a long period of high, 20-EMA crossed down the 30 EMA. Traders who entered with sell orders were able to take advantage of the bearish movement.
This strategy can be combined with trailing stops as prices move towards the expected result.
Moving Averages as Dynamic Support and Resistance Levels
MA can also be used as dynamic support and resistance. It's called dynamic lines because they are constantly changing. In the graph below, prices are in a downward trend and the EMA is acting as resistance. It tested the EMA three times before the downward movement continued.
The same goes for the bullish movement, the moving average dynamically supports prices, presenting several opportunities for buyers to enter the market.
Dynamic support and resistance breakouts
When there is a dynamic level breakout, what was support becomes resistance and what was resistance becomes support. In the example below, prices were on an upward trend with dynamic support at EMA. After a downward movement, the break occurs and the EMA starts to act as price resistance offering several opportunities for entry on the short side.
Matching with other indicators
Moving averages gain more strength when combined with other graphical analysis techniques.
Support and Resistance
In the chart below, after the bearish breakout of support at point A, prices dropped before the retraction at new resistance in B. The short entry could have happened at the point B, which in confluence with the resistance, brought down the price quotation and generated a positive result for the trader.
The candlesticks patterns, hammer in the first circle and bullish engulfing in the second one, and in confluence with the EMA, have offered two entry points for buyers before the bullish movement continued.
After a long upward movement, the prices showed below found support at the 38.2% level of fibonacci retraction in confluence with EMA's dynamic support. Right after the long entry, prices continued the upward movement.
There are several ways to take advantage of moving averages such as decision to enter and exit trades. As a trader, you must choose the strategy that best suits your style of analysis and combine execution with risk management to increase the chances of success. Remember that no strategy guarantees 100% accuracy.