Moving Average

Moving averages are a way to figure out the average price of something over a certain amount of time in the past.

They can help predict where the price might go in the future by showing areas of support and resistance.

It reduces the price fluctuations or noise in the price chart so that the viewer can see the price movement smoothly without all the ups and downs.

Below are few commonly used charts:
There are multiple type in moving averages, the most common ones are SMA and EMA.

  1. SMA

    A simple moving average (SMA) is just the average price of something over a certain period of time, example below shows the average value for 6 interval periods.

    It's calculated by adding up all the prices in that period and then dividing by the number of days. Most commonly, people use the closing prices of each day to calculate the SMA.

    • Simple moving averages (SMA) are a type of indicator that is slower to react to price movements and provides a smoother average.
    • SMAs can help eliminate false price breakouts, which can be helpful for traders.
    • However, SMAs are more lagging than other types of moving averages like EMA.
    • SMAs can act as support and resistance levels for the market.
    • They are most suitable for mid-term to long-term trading.

  2. EMA

    EMA is another type of moving average, like SMA. But unlike SMA, EMA gives more importance to the recent price data points. This means it reacts more quickly to changes in price movements compared to SMA.

    It's called as an "exponential" moving average because it gives more weight to the most recent data points.

    • Exponential Moving Averages (EMA) are similar to SMAs but react quicker to changes in price movements.
    • EMAs are more sensitive to recent price movements, making them quicker to react to changes.
    • They can be more prone to false price breakouts than SMAs.
    • EMAs are less lager than SMAs.
    • They can act as support and resistance levels in volatile markets.
    • They are most suitable for short to mid-term trading.

Moving average periods:

Traders can set the length and period for all types of moving average (SMA, EMA, etc.) based on their comfort level and trading analysis style. For a slow-moving average, a longer period is preferred. For a fast-moving average, a shorter period is preferred.

  • It's not necessary to use all the different periods and it's crossovers to enter a trade.
  • It's up to the trader to decide how they are comfortable using different period moving average to make a decision.
  • A good trader always waits for the right opportunity to enter a trade, regardless of the number of moving averages they use.

    • How to use Moving Averages?
    - There are multiple ways to use the moving averages. Below are the few examples. Please note that all the bellow examples applies to most of all different types of Moving averages(i.e SAM, EMA, TMA and others)

    1. Cross-over strategy

      Moving average crossover strategy is a popular trading technique that uses the crossover of two different moving averages to determine entry and exit points in the market.

      This strategy needs at least two moving averages to work.

      The two most commonly used moving averages are the 50-period moving average and the 200-period moving average.

      • When the shorter moving average (usually 50-period) crosses above the longer moving average (usually 200-period), it indicates a buy signal.
      • Conversely, when the shorter moving average crosses below the longer moving average, it indicates a sell signal.
      • Traders will wait for the crossover to occur and then enter a long or short position based on the direction of the crossover.
      • Traders may also use additional technical indicators, such as momentum or volume, to confirm the signal.
      • Once the position is opened, traders will typically set stop loss and take profit levels to manage their risk and lock in profits.

      Few Traders use below strategy depending on their experience and skill

      • If the last/current price crosses above any MA line(EMA-21 in above case) and closes, it can be considered as a bullish signal, indicating a potential uptrend in the market.
      • If the last/current price crosses below any MA line, it can be considered as a bearish signal, indicating a potential downtrend in the market.
      • Monitoring the relationship between the last price and MA lines can help identify potential changes in the market direction.
      • This strategy requires trading experience and skill to use in perfect time and opportunity.

    2. The Golden Cross and the Death Cross Strategy

      The Golden Cross and the Death Cross are two popular strategies that use moving averages to identify potential changes in market trends.

      A Golden Cross occurs when a short-term moving average, such as the 50-day MA, crosses above a long-term moving average, such as the 200-day MA. This is considered a bullish signal, indicating a potential uptrend in the market.

      A Death Crossoccurs when a short-term moving average, such as the 50-day MA, crosses below a long-term moving average, such as the 200-day MA. This is considered a bearish signal, indicating a potential downtrend in the market.

      • This strategy works well in trending and volatile markets, but may give false signals in sideways markets.
      • It is a lagging indicator, which means you may miss out on the exact entry point of the trade.
      • This strategy is usually preferred for long-term trading, as it may take time for the trend to develop.
      • To increase the accuracy of the signal, multiple indicators can be used in conjunction with the Golden Cross.
      • Stop loss can be set using a trend line or the lowest price of the previous candles.

    3. Dynamic Support and Resistance Strategies

      As we known that Support and resistance can be identified using horizontal lines, diagonal lines, or trend lines. Similarly Moving Averages also acts as Dynamic support and resistance.

      Dynamic support and resistance levels refer to levels that constantly change based on the current price movement. When the price of a stock falls to the moving average and touches it or breakouts, traders can consider buying or selling, but they shouldn't do so every time it happens.

      The example shown below demonstrates this concept.

      • It is often works well with Elliott wave pattern theory, which is an advanced trading strategy.
      • Scalping traders commonly use this strategy.
      • Since 90% people use moving average with period 10, 20, 50, 100 and 200 while trading, all gonna expect the price movement according to the moving average line. So we can consider its level as a dynamic Support and Resistance.
      • The dynamic support and resistance levels provided by moving averages are not as strong as horizontal and diagonal support and resistance.
      • It can be used to check levels and can help identify potential breakouts.
      • This strategy is applicable across multiple time frames.
  • Some stock markets work well with SMA but not with EMA, while others work well with EMA but not with SMA. It depends on the market they are trading in and its characteristics.
  • Moving averages are lagging indicators as they are based on past prices, which means that they may not reflect the most current market conditions or price movements.
  • Moving averages can generate false signals, particularly in choppy or sideways markets.
  • Moving averages can produce different signals depending on the time frame being used. For example, a moving average may indicate a bullish trend on a daily chart, but a bearish trend on an hourly chart.
  • Markets with highly volatile or subject to sudden price movements may not provide reliable signals using moving averages.
  • While moving averages can be a useful tool in technical analysis, they should be used in combination with other indicators for trade confirmation.

    • Example-1 : Using Moving Average as Resistance here. Short market on Price crosses and closes below SMA-200 and other Moving Average line.

    Example-2 : Using Moving Average as Dynamic Support.

    Example-3 : Using Moving Average as Dynamic Support and Resistance

    Example-4 : Market against Moving Average. Try to avoid volatile market and small interval timeframe while using Moving Average

    Example-5 : Using Moving Average as Dynamic Support zone.

    Example-6 : Moving Average Crossover strategy. Buy and Sell on crossover of moving averages.

    Example-7 : Long call on Price crosses over SMA and Short call on Price breaks SMA support line .

    Example-8 : Price bounce as it got support from SMA

    Example-9 : Moving Average Crossover strategy. Buy and Sell on crossover of moving averages.

    Example-10 : Golden Cross Strategy to enter into position

    Example-11 : Simple way to set Stop Loss as Current candle closes below MA line

    Example-12 : Golden and Death Cross





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