Crypto Trading 101: Understanding Moving Averages

This article contains NO affiliate links. 
______________________

Moving averages are popular indicators in trading analysis.  They function to track the movement of a coin’s trading price over time.  The average is called “moving” because the indicator line adjusts as the average coin price changes.  Traders use different version for different reasons.  The three main moving averages are SMA, EMA, WMA: (formulas included at the bottom):

Simple Moving Average (SMA)

SMA shows the average price over a set of days (eg, 7-days, 50-days, 200-days), generally based on the closing prices. 

Exponential Moving Average (EMA)

EMA differs from SMA by including current price data.  While SMA simply gives the mean of daily trading prices, EMA tracks “real-time” trading prices and factors the data into a unique average calculation. 

EMA is more sensitive to price movement than SMA. This doesn’t mean one is better than the other.  Each serve different functions depending on your trading strategy.

Weighted Moving Average (WMA)

Sometimes, you’ll see “Weighted Moving Average.”  WMA calculation puts more weight on recent prices in a sequence of prices and less on earlier prices.  You can think of WMA as a midway between SMA and EMA (more recent data than SMA, but not as recent as EMA).  The more recent the data calculation, the less responsive a moving average line will be.  This can be a double-edged sword.  This can be a double-edged sword.  For example, WMA and EMA will identify trends sooner than SMA, however, WMA and EMA can be “noisy” indicators if there are rapid fluctuations.  This simply means a messier indicator, as opposed to SMA producing a smoother line. 

This chart shows the three moving averages mentioned above: EMA (7-days); SMA (14-days); WMA (21-days)

How to Use Moving Averages

MAs are calculations of averages, which means they shouldn’t be used to find an exact high or low point to trade.  Rather, moving averages can be used to either validate the direction of the trend, or to spot opportunities where recent trends diverge from past trends.  Here are a couple things to look for: 

“Price Crossing MA”

When the current price indicator crosses above the MA, traders to look to sell their coins (depending on the trader’s initial purchase price). Conversely, when current prices fall below the MA, traders will either hold or buy, or sell (to minimize loss). 

“MA Crossing MA”

If you’re using more than one line on your trading chart, you’ll be assessing how an earlier trading period compares with a later period.  For example, if your chart shows a MA (50) and MA (200), you’ll use the 200-day average to give you a “bigger picture” perspective for what the shorter 50-day trend may be doing.  If the 50-day MA falls below the 200-day MA, this may be a good window for you to take advantage of.  

If you’re extra nerdy, here are the formulas for each moving average: 

EMA Formula

The exponential moving average formula is:

EMA = (closing price – previous day’s EMA) × smoothing constant + previous day’s EMA

Where the smoothing constant is:

2 ÷ (number of time periods + 1)

WMA Formula

The most recent data is more heavily weighted.  The weighting factor is determined by the time period.  For example, a 5 period/day WMA would be calculated as follows:

WMA = (P1 * 5) + (P2 * 4) + (P3 * 3) + (P4 * 2) + (P5 * 1) / (5 + 4+ 3 + 2 + 1)

Where: 

P1 = current price 

P2 = price one bar ago, etc…

__________________________

Chart credits:  Trading View | Fidelity

Disclaimer:  This article is for informational purposes only.  It is not a direct offer or solicitation of an offer to buy or sell, or a recommendation or endorsement of any products, services, or companies.  TheUtopianLife.com does not provide investment, tax, legal, or accounting advice.  Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.

Comments are closed.