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Technical Analysis 101: Moving Averages

What is a Moving Average, Exactly? 

A Moving Average is a technical analysis tool that simply identifies the trend direction of an instrument to better calculate support and resistance levels. Because it’s based on the follow up with past prices, the MA is considered to be a trend-following–or lagging–indicator.

Basically, the longer the time frame of the MA calculated is, the more it lags. A 100-day moving average has a much greater degree of lag than that of a 20-day Moving Average. Traders and investors consider the 50-day and 200-day moving averages as important trading signals.  

Moving Averages are also really flexible. No, they don’t do yoga, instead, they’re absolutely customizable to however the trader wishes them to be. If you prefer to set it at a 20-day time frame, you got it. A 200-day time frame, you also got it. Most traders like to set it at the following time periods; 15, 20, 30, 50, 100, and 200 days. Note that the shorter the period of the average is, the more sensitive it’ll be to price changes. Obviously, the longer the time span is, the less sensitive the average will be. It’s true what they say, the older you get the less sensitive to BS you are.

The time frames are chosen relative to the objectives the traders have. As you’d expect, shorter moving averages are used for short-term trading, while longer-term moving averages better suit long-term investors.

There’s no one correct time frame, choose the Moving Average that suits you and your trading strategies. There’s no shame if you keep on changing your MA, do it until you find one that fits your strategy!

Moving Averages help you predict fluctuations in the markets even if it’s a very hard job. They don’t make it easy, but they do make it a lot easier. Let me help you see it better, a rising MA shows that the instrument is in an uptrend, while a declining moving average indicates a downtrend.

An upward momentum happens when a short-term moving average crosses above a longer-term moving average. This is considered to be a bullish crossover. A downward momentum, on the other hand, confirmed with a bearish crossover, occurs when a short-term moving average crosses below a longer-term moving average.

What are the Types of Moving Averages?

Simple Moving Average

As the name indicates, it’s simple, more specifically, it’s the simplest form of a moving average. The SMA, Simple Moving Average, is calculated when the prices of the financial instruments at hand are added together. The sum of these prices should later be divided by the number of prices in the set.    

To give an example of the SMA, please look at the below graph:

In the graph, you’ll see three simple moving averages, the 50, 100, and 200 SMAs. 

These are represented by the Light Blue, Purple, and Orange colored lines respectively. So, as you can see, they give an average of the previous prices. They plot the previous prices on the line giving you a reference you can base your trading on.

Exponential Moving Average (EMA)

The exponential moving average depends hugely on the more recent prices of the instrument being traded or studied. The EMA thus gives a higher weighting to recent prices, while the SMA assigns equal weighting to all values.

Example time!

In the graph, you’ll see three exponential moving averages, the 50, 100, and 200 EMAs. These are represented by the light blue, purple, and orange colored lines respectively. They differ in trajectory than the SMAs since the EMAs are putting more weight on current prices than on old prices, so they might be giving a different outcome, it’s up to you to decide which one you like best.

The Golden Cross and the Death Cross

These two indicators express if the market is bearish or bullish. A golden cross signals a long-term bull market that’s still rising, while a death cross indicates a long-term bear market. What’s common between them, is that they both show a long-term trend by the occurrence of a short-term moving average crossing over a major long-term moving average.

Golden Cross

For the golden cross to happen, a short-term moving average needs to cross over a major long-term moving average to the upside. This is interpreted by analysts and traders as signaling an upward turn in the markets. Technically, the short-term average trends up faster than the long-term average, until they cross.

Nothing beats an example, so here it is:

We see that the short-term Moving Average (light blue line) broke through the long-term Moving Average (orange line) upwards. The crossover was neat and clean signaling that the positive momentum on this instrument is building, and that’s what happened, as the cross appeared and EURUSD skyrocketed higher after that. 

Death Cross

This is the complete opposite of the Golden Cross, so a downside moving average crossover constitutes the death cross and is understood to signal a decisive downturn in a market. When a short-term average trends down and crosses the long-term average, the death cross occurs. In other words, a Death Cross goes in the opposite direction of the Golden Cross.

Let’s take an example:

As you can see in the above image, the short-term Moving Average (represented by the light blue line), crossed the long-term Moving Average (represented by the orange line) downwards. This triggered a move lower on EURUSD. The cross was clear and signaled that the time to short this instrument is near and low. Behold, the prophecy has come true!

Death crosses are very helpful indicators because they come before the economic downturns. This is exactly what happened in 1929, 1938, 1974, and 2008 before the economic downturns. 

Where next?

Check out our second Technical Analysis Article, the Relative Strength Index.

Have Questions?

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