They are giving us the average price of last couple periods.
Simply said, you use a certain amount of candlestick closes from the past, and you calculate the average price.
For example, the value of closing prices of the last 5 candlesticks were 3, 5, 7, 6, 9.
If you want to calculate average, you will sum these values and divide by the number of them.
In this example it would be (3+5+7+6+9) / 5 = 6.
For every closing price, you can find the average of the previous 5 and the result will be a single dot that will represent their middle value.
By connecting these dots, you get the line that is called moving average.
This is how it looks like.
On the example above, we have moving average on Bitcoin chart.
This indicator doesn’t cover your chart since it is just one line that is plotted on the chart.
In this case, we have a moving average that gives us an average price for the last 21 closes.
So, every dot will include the average of the last 21 closes before it.
There are a couple of types of moving average, but we will introduce two types we think have the most usage.
The difference between those types is in the way they are being calculated.
They all have the line that matches the dots but because of different formulas, the dots are having different values and because of that the line has a different shape.
Types of mining average (MA):
1) Simple Moving Average (SMA) is the type that gets its value summing closes and dividing by the number of closes.
The example we had in the last lesson is a simple moving average.
- Exponential Moving Average (EMA) is the type that has a special formula of calculating. As you are not going to be questioned what is the formula, there is no reason to learn that formula. Ask any successful trade what is the formula, the majority will laugh at you because it is not the point of trading. The point is to know the characteristics of EMA and why it is different from SMA in this case. EMA gives more attention to recent price action and that’s why it changes and reacts faster than SMA.
Do you see the difference?
To be honest, it is very hard to notice the difference because the difference in the calculation is not that drastically
The red line is EMA while the blue one is SMA.
The difference, in general, is not that big.
It usually follows one another, but when there is some significant change in the price, EMA is the one that will act faster because its attention is more towards the latest price action.
By using EMA, you may get confirmation faster but once you get the confirmation by using SMA, it is more valid.
Our team is using both types but merely EMA.
The difference between moving averages doesn’t come only from the difference in the formula but also in the number of closes it uses.
If you use MA 3, it will use the last 3 closes.
If you use MA 100, it will use 100 closes and give you an average.
The question is which one to use?
You can use which one you want.
You can simply by trying one by one see which one acted the best in the past.
This is the process of backtesting that will give you best results.
We can suggest you to look at few: MA 8, MA 13, MA 21, MA 26, MA 50, MA 100, MA 200.
Moving averages have few usages.
We will point out three we think that are most important for you as a trader.
Before explaining its usage, we would like to say a few words on how to plot them.
All these formulas behind moving averages are not required.
You simply chose the type you want and chose how many closes to include and your moving average will be plotted on the chart.
The whole process of plotting will be explained in the course about Tradingview.
1) Identifying trend
Moving averages are used to identify the trend.
Yeah, an uptrend or a downtrend can be identified by moving average and it is straightforward.
In an uptrend, the price is above the moving average.
Once you plot moving average, if the price is above the moving average, we are in an uptrend.
For this usage, we find 21 and 26 moving averages very useful.
For general market trends, 50 and 200 are valuable.
Here we have a great example of an uptrend.
Not only that it creates higher highs and higher lows, but it is also above moving average that is confirmation of an uptrend.
In this type of trend, you want to be a buyer until the trend changes.
In a downtrend, the price is below the moving average.
After plotting moving average, if the price is below the moving average, we are in a downtrend.
When you have a chart like this one, your eyes should be looking for short opportunities as long as the price is forming lower lows and resting below the moving average.
While an uptrend and a downtrend follow some certain rules, the sideways market doesn’t follow anything.
It is just a type of market where everything possible.
Sometimes I am asking myself why people are trying to trade in the sideways market while ignoring clear up and down trends.
2) Support and resistance
We all know that support and resistance can be established and marked by trend lines, Fibonacci tools, etc…
These tools are also known as static support/resistance because they are acting as a support on a certain price level or better to say in a certain area.
On the other side, we have dynamic support and resistance areas and one of the most favorite tools to mark these levels are moving averages.
When the price is below the moving average, it is considered as resistance.
When price crosses above the moving average, the previous resistance turns into support.
Here is an example that shows us the best usage of moving averages as a tool to identify support and resistance.
Starting from the left, you can see how it acted as a resistance there times.
We always suggest looking at the closing price.
Even if at some moment, the price is above the moving average, it doesn’t mean it is broken.
It is also not broken if it closes above and the next candle drops and closes below and invalidates the previous candlestick.
You want to trade a setup where you get confirmation and you can’t get confirmation without candlestick close.
If you are looking to buy the breakout, you are not buying at resistance but once it is broken and tested from above.
After the breakout, we had a great example of a bullish setup.
The setup that is very hot to play is the one that got front run by buyers because it was too bullish.
3) Entry confirmation
Some people use moving averages to get entry confirmation.
The way that they use it is very simple.
They plot two moving averages on the same chart.
Most popular pairs are 9 and 26, 13 and 21, 21 and 55,…
Here is an example.
You would open a short position or sell your coins in the upper blue area and buy them back or open a long position in the lower blue area.
While this can be a very profitable and more important very easy strategy that doesn’t require anything else to use, it has one big drawback.
It doesn’t give you stop loss area and requires you to close it once it gives you the sign (crossover).
That’s not that hard in the non-volatile market but when we get it after the big move, the loss can seriously damage the account balance.
We like to look at crossovers to get a sign of trend direction and we would like to trade with trend direction but we are not using moving average crosses as an entry confirmation.
Milos is an independent trader, with a background in journalism and publishing. Nomadic by nature, he’s lived in four different countries this decade. He’s fascinated by Blockchain technologies’ potential to reshape all aspects of our lives. Milos got into Bitcoin while completing his degree and hasn’t looked back since, writing about anything crypto-related. He is the co-founder of the Cryptoaims and he has a strong passion to educate people about this revolutionary technology.