Charles Dow — the founder of the Wall Street Journal, was among the first people to realize that in terms of market trends, history repeats itself. This is the basis of technical analysis: market trends repeat themselves, and when you monitor them, they can predict the future of a particular financial asset, or even a market overall.
Traders have been using tools called technical indicators for technical analysis in the stock market and other traditional financial markets for years now, and it’s only in recent times that crypto traders have started using them too. Among crypto investors across the globe, the moving average is one of the most used technical indicators.
In this post, we take a look at what moving averages are, the different types of moving averages, and how exactly this technical indicator is used in the crypto market.
What Are Moving Averages?
Moving averages or MA are one of the least complex and popular technical indicators in the crypto market. To put it simply, moving averages show the average value of a particular asset’s price over a specified period of time; the technical indicator is generally plotted alongside the closing price.
The moving averages eliminate the effects of random, short-term price changes within the selected time span. The moving averages use historical market data to perform their assessment, and therefore they are known as lagging or trend following technical indicators.
Types of Moving Averages:
Crypto traders may utilize a number of different types of moving averages as per their trading objective and preferences. There are three popular types of moving averages, which are the SMA or the simple moving averages, the WMA or the Weighted Moving Averages, and the EMA or the Exponential Moving Averages. The primary distinction between all three is the level of importance the most recent data receives.
- The SMA or the Simple Moving Averages: This is the simplest form of the moving averages technical indicator. The SMA is decided by figuring out the average of any set of values; so to determine the SMA for a particular time period, you’d need to sum up the many prices of an asset during that time, and then divide the sum by the number of prices in the set of prices.
If you’re calculating a 30 day SMA for a crypto, you have to add up the prices in the past 30 days, and divide it by 30. The SMA pays equal importance to all prices in the data set, even the oldest ones. However, if your SMA is set to calculate the average of the past 30 days’ worth of prices, it will keep updating itself with every passing day and eliminate older information the moment new data arrives.
2. The WMA or the Weighted Moving Averages: In case of the WMA, again past data is taken into account to come upon an average. The basic difference is that for the weighted moving averages, the prices used are weighted by their level of closeness to the current value of the given asset. Newer data thus gets more weight, while older data is not considered that important. The WMA is closer to the price chart.
3. The EMA or the Exponential Moving Averages: The EMA too calculates past price changes for an asset to produce an average. However, in the case of the exponential moving averages, the recent prices get more importance over the older ones, so the result is always more reactive to newer price information.
When the EMA is calculated, the prices are not weighted like the WMA, but they are multiplied by specific ratios as per their level of remoteness. The more current prices are multiplied by higher ratios. The EMA, just like the WMA, is, therefore, closer to the price chart.
All three of the aforementioned moving averages are broadly used by crypto traders; however, when compared, the EMA is definitely the better option to point out sudden price shifts or reversals. Traders entering short-term trades usually prefer the exponential moving averages for that exact reason.
The MACD or the Moving Average Convergence Divergence:
When moving averages are combined with other technical indicators, you can get even more precise results out of the technical analysis you perform. The use of several moving averages can generally help a trader form a better and more productive trading strategy. For instance, when moving averages are incorporated with the technical indicator MACD or the Moving Average Convergence Divergence, you can more accurately root out ‘buy’ or ‘sell’ signals.
The Moving Average Convergence Divergence technical indicator is formed with two lines- one is the MACD line and the other the signal line. The Moving Average Convergence Divergence helps traders estimate the momentum of the market by using two separate moving averages of a certain crypto’s price and keeping track of the relationship between the two lines on the chart.
If the MACD line on the chart goes over the signal line, it signifies that prices are rising, and if the MACD line dips below the signal line, it shows dropping prices.
Uses of Moving Averages:
You can adjust the time period while calculating an average on the moving averages technical indicator, based on your various trading objectives. Usually, traders use the time periods of 15, 20, 30, 50, 100, and 200 days while determining moving averages, but of course, you can customize your moving average according to your trading objectives. For short-term trades, traders make use of relatively shorter moving averages, while for long-term trading, traders use long-term moving averages.
Moving averages are used to identify the direction of the trend; when you see rising moving averages, you can determine that the crypto in question is in an uptrend. A dipping moving average, on the other hand, says the crypto asset is in a downtrend. A ‘buy’ signal is put out when a crypto’s price goes above its moving average, and a ‘sell’ signal is sent out when its price is dropping under its moving average.
Moving averages also help you figure out support and resistance levels. As mentioned before, they smoothen out the disturbance caused by random, short-term price fluctuations, so moving averages can help you better root out significant underlying trends.
Bitcoin’s Past 200 Week Moving Average:
To demonstrate how the moving averages technical indicator works, we can take Bitcoin and its price data from the past 200 weeks for example. It’s been noticed that in every major market cycle (accumulation, bullish market, distribution, bearish market, and repeat), Bitcoin’s value historically bottoms out near the 200 weeks moving average.
In the chart above, the indicator is using a colour heatmap according to the percentage of increases of that 200-week moving average. As per the monthly percentage increase of the 200-week moving average, a specific colour is used on the price chart shown above.
How you can read the chart is by monitoring the monthly colour change. For instance, historically, the orange and red dots have signified a profitable time to sell Bitcoin while the market overheats. On the other hand, times, when we can see purple dots close to the 200-week moving average, has historically proven to be a good time to buy Bitcoin. In the past 6 months, as Bitcoin’s price has swung around wildly and in June, even dipped below $30,000, marking a record low for the crypto, we can still see the indicator signifying now as a good time to buy Bitcoin.
And that was all the basics of moving averages you need to know! To trade in cryptocurrencies in India, you can give our website a visit!