Moving averages are one of the most widely used charting indicators, both by human traders and computer trading algorithms. Given their widespread use, moving averages often have a ‘self fulfilling’ accuracy to their predictions. The purpose of this guide is to explain the basics of how to use moving averages in your trading.
● Moving averages smooth out noise in price charts and can reveal underlying trends
● Moving averages remove emotion from trading decisions
● Moving averages can act as support and resistance levels
● Moving averages can help signal trend reversals
● Moving averages work better in trending markets
How to Use Moving Averages
There are two main types of moving averages:
Simple moving average (SMA): takes the average price over a set number of days.
Exponential moving average (EMA): takes a weighted average that gives more weight to recent prices.
All of the strategies in this article will work using both SMA and EMA. Let’s look at how to plot a SMA on the BSTE platform:
Step 1: Find a chart on the BTSE platform.
Step 2: Click on the “Indicators” button in the top chart toolbar.
Step 3: Choose “Moving Average” from the drop down menu.
Step 4: Click on the “Format” icon
Step 5: Click on the “Inputs” tab and set desired “Length” – we have chosen 30.
Step 6: Sit back and admire your beautiful 30 Day Simple Moving Average.
Using Moving Averages in Your Trading
● Support is a level where traders anticipate increased buying.
● Resistance is a level where traders anticipate increased selling.
● Shorter period moving averages are useful for short-term trading.
● Longer period moving averages are useful for longer-term trading.
When price is supported near the moving average, the trend is likely bullish. The inverse is also true, so when price fails resistance near its moving average, the trend is likely bearish.
Basic MA strategy:
Moving averages work better in trending markets. It is typically best to trade with a long bias when price crosses from below to above the moving average. Alternatively, it is advisable to trade with a short bias when price crosses from above to below the moving average.
● Trade with a short bias after moving average support becomes resistance.
● Trade with a long bias after moving average resistance becomes support.
● This strategy allows for favorable risk/reward stop losses 1 or 2 ATR below/above the new moving average support/resistance.
The example below shows some of the instances where moving average support became resistance and vice versa:
Moving Average Crossover Strategy
Step 1: Plot a shorter-term moving average (30 day) over a longer term moving average (80 day).
This strategy initiates a buy signal when the short-term average (gray) crosses from below to above the longer-term moving average (blue). Subsequently, it signals a sell when the short-term moving average crosses from above to below the longer-term moving average.
In this cherry-picked example, the strategy buys at ~$3,600 and sells at ~$10,600. To reiterate, this strategy only works well in trending markets. The key benefit of the moving average crossover strategy is its automated and emotionless approach to entering and exiting the market.
● Combine the moving average crossover strategy with other trend identification indicators such as trendlines or RSI support and resistance to reduce ‘whipsaw’ losses in sideways markets.
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