A proper trading strategy involves careful calculations with precise entry and exit points. A moving average (MA) is a technical indicator used to smooth out price data on various assets.
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What Is a Moving Average?
A moving average is useful in formulating a trading plan, especially in times of unpredictable price fluctuations that may distort normal price action. This is because the MA of assets can help filter out random price movements, helping you come up with a clearer price trend to base your strategy. Note that an MA is considered a lagging indicator because it follows past prices.
Several types of traders can find various MAs useful in their strategies, from investors to scalp traders, to momentum traders, among many others.
Types of Moving Averages
Moving averages vary in how they are calculated, but they all give traders important data points that they can implement in their trading strategies.
What Is an Exponential Moving Average (EMA)?
How to Use Exponential Moving Average (EMA) in Trading?
An EMA can be utilized as an indicator for buy and sell signals and is usually used by day traders who prefer to execute trades quickly.
One strategy that is commonly used is plotting two EMAs, a long-term line at 50, 100, and 200-day periods, and a short-term line at 12 and 26-day periods. Note that the parameters may vary strongly as they are dependent on your strategy.
How Is Exponential Moving Average (EMA) Calculated?
What Is a Smoothed Moving Average (SMMA) and How to Calculate It?
It is calculated by the sum of previous SMMAs from the current prices.
The formula for the SMMA is:
What Is a Simple Moving Average (SMA)?
The Simple Moving Average (SMA) looks at the average of an asset based on its recent price history. It is calculated by adding recent prices and dividing them based on the time period for the average. Its purpose is to smooth out price data through a continuously updating average price to indicate a trend.
If the SMA is moving up, then it is likely an uptrend. If it is going down, then the trend is likely heading downwards. Traders usually use the 200-bar SMA for a long-term trend indication while the 50-bar SMA is mostly used for intermediate trends.
Some traders use the SMA as a trading signal. When the price goes above the SMA, it might signal an upward direction. When it drops below the SMA, it might signal a downward price movement.
Crossing SMAs can also be used as a signal by using short period and long period SMAs. If a short period SMA meets and goes above the long period SMA, it might signal an upward move. If a short period SMA meets a long period SMA and goes below, it might signal a possible downward move.
How Is a Simple Moving Average (SMA) Calculated?
An SMA can be calculated by getting the average of asset price values over a specific time period.
SMA = (A1+A2+...+An)/n ; n = number of total periods, An = the price of an asset at period n
What Is a Weighted Moving Average (WMA)?
A Weighted Moving Average (WMA) is an indicator that places a heavier weighting on recent price data than past data, with the sum of the weighting adding up to 1 or 100%.
A WMA is also indicative of a potential trend movement, which traders use to reveal buy and sell signals. When an asset’s price goes down near or below the WMA, this may indicate a buy signal. A sell signal is often seen in price movements above or towards the WMA.
You can see support levels at the areas where the WMA rises, as well as resistance price points where a WMA falls. Note that while a WMA can be used to validate whether your trade goes with the momentum of an asset’s price movement, it is not an indicator for an asset price’s top or bottom.
How Is Weighted Moving Average (WMA) Calculated?
The weighting factor must always be considered when calculating the WMA. A 5 period WMA, for instance, can be computed this way.
WMA = (P1 * 5) + (P2 * 4) + (P3 * 3) + (P4 * 2) + (P5 * 1) / (5 + 4+ 3 + 2 + 1)
P1 refers to the current price, P2 refers to the price one bar behind, and other Pn legends go far behind the previous price bars.
How Should You Use a Moving Average Indicator?
Furthermore, an MA also has a certain drawback due to its dependence on historical data, which could make its patterns random at times.
Technical analysis (TA) can only take you so far as well. It’s important to stay on top of market conditions and review the fundamentals of a project, the prevailing market sentiments, and short and long-term trends that might impact the price behavior of its underlying asset.