Trading 101: What Is a Moving Average and How to Use It in Trading?
Trading Analysis

Trading 101: What Is a Moving Average and How to Use It in Trading?

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10 months ago

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.

Trading 101: What Is a Moving Average and How to Use It in Trading?

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A proper trading strategy involves careful calculations with precise entry and exit points. Unfortunately, some players confuse trading with investing. They purchase an asset and simply wait for it to rise in value (also known as HODL), which could take a long time. However, if their purchased asset dips, they tend to sell at a loss.
This is a common pitfall for newbies in the crypto space, which is why it is important for everyone who wants to become a trader to learn the proper tools, including moving averages.

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What Is a Moving Average?

A moving average (MA) is an indicator used by traders in technical analysis to smooth out price data on various assets. A moving average appears as a line in a chart, which tracks a constantly calculated average price of a particular asset based on a specific time period, which can be 5 minutes, 10 days, 1 month, or any other time frame set by a trader.

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)?

An exponential moving average (EMA) is an indicator that looks at the trend direction of an asset while placing more weight on its average price movement from recent data relative to older data. An EMA is more sensitive to price movements, which makes it suitable for detecting particular trends earlier than other types of MAs.

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.

A buy signal can occur when a ‘golden cross’ appears, or when a short-term EMA goes above a long-term EMA. The sell signal, or the ‘death cross,’ appears when the short-term EMA dips below the long-term EMA.
You can also use the EMA to determine support and resistance levels. If the price meets the EMA line from above, that can be considered a support level. If it meets the EMA line from below, it may be a resistance level.

How Is Exponential Moving Average (EMA) Calculated?

The EMA is calculated by the value of previous EMAs and the current price. This is how EMA is calculated:

What Is a Smoothed Moving Average (SMMA) and How to Calculate It?

A Smoothed Moving Average (SMMA) is an EMA with a longer period. It is an indicator that calculates data on recent and historic prices, including old prices in the calculation but with minimal weight.

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.

A WMA can also be used to determine support and resistance areas.

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?

Using different sets of moving averages can supplement a trading strategy by limiting the amount of ‘noise’ in an asset’s price action, as well as helping traders gain a clearer view of trends and strategize their entry and exit plans. Ultimately, it increases your chances of having successful trades when implemented in your trading strategy.
However, it is crucial to note that using an MA is not a trading strategy, per se, and should not be viewed as such. It is simply a tool that you can use as part of your strategy. In order to earn like a professional trader, you need to act like one, and this means having a real trading strategy that you follow religiously and optimize as you go.

Furthermore, an MA also has a certain drawback due to its dependence on historical data, which could make its patterns random at times.

Lastly, volatile assets like cryptocurrencies don’t always respect trading signals, which means that you shouldn’t expect every trade to go your way despite doing everything right, technically.

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.

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