Technical Analysis (TA) is not new to the world of trading and investing. From traditional portfolios to cryptocurrencies like Bitcoin and Ethereum, TA indicators have a simple goal: to use existing information to make more informed decisions that are likely to result in the desired outcome for the trader. As markets grow more complex, hundreds of TA indicators have been produced over the past few decades, but only a few have achieved the same level of popularity and consistent use as the Moving Average (MA) indicator.

While there are different variations of the MA indicator, the purpose behind them is to provide clarity to trading charts. This goal is achieved by smoothing out the charts, creating a trend indicator that is easier to analyze. Because they rely solely on past data, they are classified as Lagging Indicators because they look at what has happened previously when trying to identify market trends. Regardless, they still have great power to cut through the noise and help determine where a market may be headed.

Different Types of Moving Averages

There are several different types of MAs that traders can use, not only in day trading and swing trading, but also in long-term planning. Despite the various types, MAs are most commonly divided into two categories: simple moving averages (SMAs) and exponential moving averages (EMAs). Depending on the market and the desired outcome, traders can choose which indicators are most likely to benefit their trading plans and setups.

The Simple Moving Average

The SMA takes data from a specific time period and produces the average price of the asset used for data collection. The difference between a SMA and a regular average of past prices is that with a SMA, as soon as a new data set is input, the oldest set is disregarded. So if a simple moving average calculates data from 10 days, the entire set will be constantly updated to include only the last 10 days.

It is important to remember that all data entered into an SMA is balanced equally, regardless of how recently it was entered. Traders who choose to give more importance to the most recent data often claim that SMA balancing is detrimental to technical analysis. So, the exponential moving average was created to solve this problem.

The Exponential Moving Average

EMAs are similar to SMAs in that they provide technical analysis based on past price movements. However, the equation is a bit more complicated because an EMA gives more importance and value to more recent entries. While both averages are important and widely used, the EMA is much faster at identifying sudden price movements and reversals.

Since EMAs are more likely to project price reversals faster than SMAs, they are generally used by traders who are trading assets in the short term. It is crucial for any professional or investor to choose the type of moving average according to their personal strategies and goals, adjusting the settings accordingly.

How to use Moving Averages

Because MAs use past prices rather than current prices, they have a lag time. The larger the data set, the larger the lag time. For example, a moving average that looks at the last 100 days will respond more slowly to new information than an MA that only looks at the last 10 days. This is because adding new data to a large data set will have little effect on the overall numbers and results.

Both are advantageous, it all depends on the trader’s setup. Larger data sets benefit long-term investors because they are less affected by significant changes due to one or two large fluctuations. Short-term traders are typically favored by a smaller data set, allowing for faster, more reactive trading with the short-term objective in mind.

In traditional markets, 50-, 100-, and 200-day MAs are the most commonly used. The 50- and 200-day MAs are most closely watched by equity traders, and any break above or below these lines is often considered an important trading signal, especially when crossovers occur. The same applies to cryptocurrency trading, but due to the volatile and 24/7 market, MA settings and trading strategies may vary depending on the trader’s profile.

Crossover Signs

Typically, an ascending MA suggests an uptrend and a descending MA indicates a downtrend. However, a moving average by itself is not a truly reliable indicator. Therefore, they are often used in combination to detect bullish and bearish crossover points.

A crossover point is created when two different MAs cross each other on a chart. A bullish crossover (also known as a Golden Cross) occurs when a short-term MA crosses above a longer-term MA, suggesting the start of an uptrend. In contrast, a bearish crossover (or Death Cross) occurs when a short-term MA crosses below a longer-term MA, indicating the start of a downtrend.

Other Important Factors

The examples used so far have all been in terms of days, but that is not the only requirement when analyzing MAs. Those involved in day trading may be much more interested in the performance of an asset over the past two or three hours, not two or three months. Different time frames can be applied to the equations used to calculate moving averages, and as long as these time frames are consistent with the trading strategy, the resulting data can be useful.

One of the major drawbacks of MAs is their slowness. Because MAs are lagging indicators that consider past price movements, the signals come too late in some cases. For example, a bullish crossover may suggest a buy, but this only happens after a large increase in price. This indicates that even if the uptrend continues, potential profits may have been lost in the period between the price increase and the crossover signal. Or, even worse, a false golden cross may prompt a trader to buy at the top of the price just before a decline (these false buy signals are often called bull traps).

Moving Averages are powerful TA indicators and also one of the most widely used. The ability to analyze market trends in a data-driven manner provides excellent insight into the performance of these markets. Keep in mind, however, that MA and crossover signals should not be used alone and it is always safer to combine different TA indicators in order to avoid false signals.