What are Moving Averages?

What are Moving Averages?

There are several lagging indicators that are very popular among traders, one of which is the Moving Averages (MA). We categorise these indicators as lagging indicators because they are generated based on historical data. Let’s dive a little deeper today on MAs and what they are all about!

What is it?

Moving average is basically a formula used to calculate average closing prices of a market over longer periods of time, typically weeks or even months, to identify trends for trading. Simply put, it’s a good way to help smooth out price swings so we can identify the true trend from market “noise”. By looking at the slope the MA forms, you can better identify the trend direction, as opposed to the choppy charts of candlesticks.

MAs can be a very good indicator of the current market momentum, which is essential as momentum measures the rate of change in prices as opposed to the actual price changes themselves. So that would be really helpful for traders to draw inferences on the market direction.

How do we choose a proper length for it?

As mentioned, the MA could reflect weeks or months. So, how exactly does that work? The length generally refers to the number of reporting periods included in the MA calculation (and I will not bore you with the painful formulas) and it affects how the MA is displayed on your price chart. The shorter the length, the fewer the data points included in the MA calculation, and hence the closer the MA stays to the current price.

Such a length makes the MA less useful as it may then offer less insight into the overall trend as opposed to you looking at the current price itself! The longer the length, the more data points included and hence the less affected the overall slope is by any particular price point.

However, price fluctuations may become way too “smooth” if there are too many data points and the problem is that you won’t be able to spot any kind of trend! Indeed, it’s not that simple, but a good trader will be able to find the ideal length that works well for him. Verified signal providers in Omada have been trading for ages, so MA is an indicator they are extremely familiar with! That’s why copy trading is a good way for you to reap profits with the help of professionals while still taking time to learn to trade at your own pace!

What are the types of MAs?

The two most commonly used MAs are the simple moving average (SMA) and the exponential moving average (EMA).

Basically, the SMA is calculated by dividing the total number of prices in a series by the sum of those prices. For instance, a five-period moving average can be determined by adding the five prices and dividing the result by five. It’s as *simple* as that!

Unlike SMA that calculates the mean of the price data, EMA gives more weight to current data. The latest price data will have a greater impact on the moving average as compared to older price data. More precisely, EMA gives more weighting to recent prices, while SMA gives equal weighting to all prices. EMA is thus more reactive to the latest price change and the results are considerably more timely. In fact, this makes EMA the preferred MA among many traders.

Blue Line – EMA 200

Red Line – SMA 200

3 Major ways to use MAs

1. To find out the trend direction

This one is pretty straightforward. When prices are trending higher, the moving average will change to reflect higher prices by moving higher as well. This can be seen as a bullish indication, signaling that traders are looking for opportunities to buy. Conversely, if prices are continuously trading below the moving average indicator, it would imply that traders would want to sell because the market is signaling a downward  trend.

2. To find the support and resistance levels

Once a trade has been entered, MAs can be used to establish support and resistance levels. A trader may enter the market on a retest of the MA if the MA is rising. We can also utilise the MA as a stop loss level if the trader is already long in an up trending market. With downtrends, the opposite would be true.

3. Applying multiple moving averages to read the charts

Traders frequently use multiple MA indicators on a single chart. This enables them to assess both short term and longer term market trends concurrently. When the price crosses above or below the plotted levels on the graph, it can be inferred as either strength or weakness for a particular currency pair.

Many traders will look to see if the lines will cross when using several MAs on a single chart. There are two common phenomena that traders have created fancy terms for: ‘The Golden Cross’ and ‘The Death Cross’. The former occurs when a bullish pattern forms, while the latter, when a bearish pattern forms. When the short-term moving average (say, the 50-day MA) crosses above the longer term moving average (say, the 200-day MA), a Golden Cross arises:

Red Line – 200 MA

Green Line – 50 MA

A Death Cross occurs when the opposite happens:

Blue Line – 200 MA

Red Line – 50 MA

Long-term traders out there should consider closing your positions when you see a Death Cross, while short-term traders should close your positions once you see a Golden Cross appearing.

3 Major ways to use MAs

MAs are very popular among traders because they can collate data from a specific time period into this ‘bird’s-eye view’ for easily identifiable trends and changes. In order to trade successfully, it is essential for us to be able to foresee the market direction and that’s where MAs come in handy. By being able to identify the average price trends of a market, as well as the changes over time, we can better decide what our next moves should be. Omada’s verified signal providers are professional traders who have had tons of trading experience and will be able to discern market “noise” from actual useful price trends, so why not give us a shot right away?