What are Moving Averages (MA)?

Moving averages are the basic elements used by traders in technical analysis. Their most important asset is their objectivity and great ease of interpretation – which cannot be said, for example, of candlestick formations, which are characterized by great freedom of interpretation and can be interpreted differently, depending on support levels and trend lines, which each trader determines himself.

Using moving averages, we can easily illustrate the trend in the market. Correct interpretation also allows to read signals, indicating its reversal. Thus, they are used both for preparing individual strategies and complex trading systems that banks and hedge funds use.

What aspects affect moving averages?

The moving average takes into account the average prices of past periods. For example, if you decide to calculate the moving average of the last five periods on the daily chart then you will be able to include prices from the last five days of trading. On the next day, the most recent price will be added to the average, and the price from the first day that was included in the average on the previous day will drop out.

Among the most important variables in a rolling setting are:

• Value – calculated on the basis of opening prices, maximum prices, minimum prices and closing prices.
• Period – determined by market, interval, and investment horizon.
• Type of average – selected from: simple moving averages, exponential moving averages and linearly weighted moving averages.

What types of moving averages do we have?

Simple Moving Average (SMA)

This is an average of prices, which is calculated as the sum of prices from period (depending on the average of opening, closing, maximum and minimum prices) divided by the number of periods. When it comes to the average of the last five periods on the daily interval from the maximum prices, the prices of at most the last five days are summed – and then divided by five.

Example:

For the average of the last 100 periods on the minute interval from the closing prices, the closing prices of the last 100 minutes of trading will be summed up and then divided by 100.

Exponential Moving Average (EMA)

An exponential moving average is a weighted average whose weight is not changed linearly, but exponentially. It is calculated on the basis of a formula that allows to give higher weight to much more recent periods and less weight to periods that are more distant – remember each period has a different weight.

Example:

If we calculate an exponential weighted average of 10 periods then the price of the period 10 periods away from the current price will be the least important, and the last price will be the most important.

Linear Weighted Moving Average (LWMA)

It is calculated very similarly to a moving average exponential, with one difference – the weight of successive periods increases linearly. In the case of an upward or downward trend, a longer period is usually taken into account, with the difference that in this case the weight of successive periods means linear growth.

Moving averages – application

Moving averages are among the most common indicators that are used in technical analysis. They are usually used in accordance with the indicators of confirmation of a trend change, that is, as an delayed oscillator. It allows you to quickly and easily examine the trend prevailing on a given instrument, which allows you to make a meticulous analysis of price charts. Thanks to specific arrangement, they allow you to show both the trend, the level of the slope and its strength.

They are usually used as support and resistance lines for more significant price changes. It is assumed that breaking the moving average from above is a sell signal, and breaking it from below means from turn a buy signal.

Many traders use two or more moving averages – one faster and the other slower (medium or long-term). Breaking the slower average by the faster one from below is in most cases a sell signal.

Using the Fibonacci sequence

Some investment strategies use the Fibonacci sequence for analysis – a rising average sloping to a level at an angle greater than 45 degrees helps to indicate a strong upward trend, while one sloping at a smaller angle indicates a weaker trend. A declining moving average is associated with a falling price, the so-called south trend.

Advantages and disadvantages – moving averages

Strengths will include:

• wide range of application in investment strategies
• clear buy and sell signals
• ability to determine the direction and strength of the trend
• Can be used in all markets
• popularity when it comes to use in technical analysis

Disadvantages include:

• the need to filter signals
• The need to adapt the indicator to each instrument and interval

Wide range of use

The great advantage of moving averages is that they can be used in any market, by any trader at any interval. They are the basis of technical analysis, through the use of MACD (Moving Average Covergence Divergence). In turn, SMA or EMA are used as signal lines for various technical analysis tools.

It is worth remembering that there is no one universal means of using moving averages. This means that it takes a lot of time to test them and adjust them to your own strategies. Playing many cases is definitely worth the candle – but it requires flexibility and adaptability, which is best tested in a demo account to avoid exposing yourself to too much loss.

Moving averages can be used individually, as well as in sets, and in combination with other technical analysis indicators – such as MACD, RSI or stochastic oscillator.