Most of us, when first entering the cryptocurrency market, don’t know many technical analysis tools. So we resort to some essential statistical tools, such as the moving average.
This article hopes you remember some statistical concepts and start applying them in your technical analysis. There are several moving averages, such as the simple, exponential, and weighted moving average. We are going to discuss its differences, calculations, and some strats for your trading!
Characteristics of Moving Averages
Before describing the different MAs, let’s talk about some generalities to get this metric better. According to Martin Pring in his book “Technical Analysis Explained,” MAs have the following characteristics:
- MA is a smoothed version of a trend. The average is an area of support and resistance. The more times the MA acts as a support/resistance, the greater the significance when it’s violated.
- If MA is flat or has already changed directions, its violation is fairly conclusive proof that the previous trend has reversed.
- If price violates MA while still proceeding in the previous direction, it’s a preliminary warning for a trend reversal. Likewise, flattening or changing MA’s direction are reversal confirmations.
- The longer the time of a MA, the greater the significance of a crossover signal. For example, a 9-month MA crossover is more significant than a 9-week MA crossover.
Lastly, for readers who are wondering what a period is, let us explain it briefly. The periods are the amount of data that an MA will use. For instance, the 30-day MA uses 30 days’ worth of data to make the average. Also, if you see a 30-period MA, that means 30 data regardless of the time basis of your chart.
The moving average and its variations
Generally speaking, we can say that all the variations of the moving average can be applied to predict trends. With the correct use of these tools, we will know when it is convenient to enter or exit a market. Moving averages can be calculated for different prices (open, close, high, low). However, it is more common to use it with closing prices. Moving averages can be used individually or in conjunction with other statistical tools.
A clear example is the Bollinger bands, which combine the moving average and the standard deviation. In the following paragraphs, we mention the differences between the different moving averages and how they are calculated.
Simple moving average (SMA)
The simple moving average is obtained by summing all the recent data points for many simple periods. Then divide the total sum by the number of periods.
Equation 1: Simple Moving Average (SMA)
SMA: is the value of the simple moving average.
Vn:The price of the asset in period n.
n: the total number of periods
Exponential Moving Average (EMA)
The exponential moving average, unlike the simple moving average, gives more weight to more recent prices. In other words, the exponential moving average is more sensitive to recent price changes. To calculate the value of the exponential moving average (EMA) we must do three steps. To begin with, we must calculate the value of the simple moving average. Where the value of the simple moving average will be the first value of the exponential moving average. As a second step we must calculate the value of the multiplier, which is given by equation two.
Equation 2: Value of the multiplier, for the exponential moving average
Finally, we must apply a third equation to obtain the current value of the exponential moving average.
Equation 3: Present value of the Exponential Moving Average
EMA previous: EMA value for the last period.
Weighted Moving Average (WMA)
The weighted moving average, like the exponential moving average, gives greater weight to current values. In this tool, the most recent data are weighted more heavily than the older ones. The total value of the weights must be equal to 1 or 100%. To calculate the value of this average, we start by determining the weights for each number, always remembering that the most recent data has a higher weighting. Then we will have to multiply each price by its weighting factor, which we assigned in the previous step. Finally we must apply the following equation.
Equation 4: Weighted moving average
WMA: Weighted moving average
Vn:The weighted asset price over time period n
n: Period of study
Reading the Moving Averages
As we said earlier, the Moving Averages work as a support/resistance line. So, the easiest way to read this metric is: buys when the price is above the MA; sells when the price is below the MA. However, remember always to consider the characteristics of the MAs for your analysis.
On another note, you’ll have to pay attention to two key aspects: crossovers and the distance between price and MA. Crossovers help you identify price reversals. However, they happen many times, so you need to filter false signals. A way to validate a crossover is to wait until 2 to 3 periods. Then, if the price still on the other side, it is a validated crossover.
Now, the distance between price and MAs helps to identify if the asset is overbought or oversold. The more space, the more chances for the price to converge with the MA.
And last but not least, signals for SMA and WMA or EMA are distinct. SMA denotes a signal by validating a crossover with the price. WMA or EMA is more sensitive to price changes, so the call to action is on peaks and valleys formations.
Advancing the MA. Consist on shifting the MA to the right of the chart. It helps to filter out false signals by delaying crossovers. The shift hasn’t a specific number; you’ll have to experiment yourself for the best fit. But, if you want a number, investors usually use the square root of the MA period. For example, you have to shift 5 days a 25 day MA. Therefore, if your MA is on July 5th, advanced MA will be on July 10th.
The deadly crossover. The main focus of this strategy is to identify a sharp price move after the accumulation period. The way it works is plotting several MAs and observing when they converge. The price movement typically occurs after the convergence, so you can be ready to execute your decision!
As we see, the moving average is one of the most influential metrics. It’s a pillar for Technical Analysis because it gives us many insights into the price, trend, and overbought or oversold evidence. But, also, it is a brick for many other metrics., like Bollinger bands, RSI, or MACD.
It’s a simple metric in a complex environment because you can change many parameters to fit your strategy. Lastly, as the wise Pring said:
Do not search for perfection. Search for consistencyMartin Pringe