Moving Averages

Do you remember moving averages from your class? If you don’t, you aren’t alone, as many of us don’t remember what the Math teacher said. 

But I am not talking about solving some complex Math equation here, I am talking about the moving averages indicator. 

Yeah, there is an indicator called moving average, and it is considered one of the most popular indicators out there. 

So, let’s see what the indicator has to offer.

What is the Moving Averages indicator?

In the exciting realm of technical analysis, a moving average is a handy tool used by traders to get a sense of the average closing price of a market during a specific timeframe. 

The primary purpose of the moving average is to smooth out the short-term fluctuations and noise in the market. 

Calculating the average closing price over a chosen time period, it helps traders get a clearer picture of the overall trend in a simple and easy-to-understand manner.

Types of MAs

Now, when it comes to moving averages, traders often use two popular types: the simple moving average (SMA) and the exponential moving average (EMA).

SMA

Let’s start with the simple moving average (SMA). As its name suggests, it’s a straightforward calculation. You just divide the sum of all the closing prices for the specified period by the number of days in that period. 

The beauty of the SMA lies in its simplicity – every data point is given equal weight.

EMA

On the other hand, we have the more sophisticated exponential moving average (EMA). The EMA, unlike its simple cousin, is a bit more dynamic. It gives more weight to the most recent prices, reflecting the belief that the latest market movements carry more significance in predicting future trends. 

So, if you love keeping a close eye on current market action, the EMA might be your go-to moving average.

Here’s something interesting to remember: the longer the period you choose for the moving average, the more lag you’ll encounter. 

It makes sense if you think about it. A 200-day moving average, for example, considers prices over the past 200 days, so it won’t be as agile in responding to rapid market changes as a 20-day moving average. 

How to use moving averages? 

Now that you know what moving averages are, let’s talk about how to use them. 

There are three ways MAs can help you:

Finding the direction of the trend

Moving averages are great tools for identifying the prevailing trend in the market. When prices consistently trend higher, the moving average will also increase, signaling a bullish trend. 

Conversely, if prices are trading below the moving average, it suggests a downward trend.

As support and resistance levels

Once a trader has entered a position, moving averages can serve as dynamic support and resistance levels. 

In an uptrend, if the moving average is trending higher, traders may consider entering the market on a retest of the moving average, as it acts as a support level. 

Similarly, the moving average can be used as a stop-loss level for traders already in a long position. In a downtrend, the moving average can serve as a resistance level.

Crossovers

The crossovers of moving averages play a vital role in trading strategies. The “Golden Cross” occurs when a short-term moving average (20-day MA) crosses above a long-term moving average (200-day MA), indicating a potential bullish trend. 

On the other hand, the “Death Cross” happens when the short-term moving average crosses below the long-term moving average, signaling a potential bearish trend. 

These crossovers can serve as significant trading signals for opening and closing positions.

Final thoughts 

So, there you go! MAs are essential to the technical trading world, and some traders swore by them. If you want to try the MA, you can reread this guide and apply on the demo account. 

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