Moving Average is a method of smoothing the price data into a trend-following indicator. Moving Average is based on the asset prices over a predefined period of time in the past. The indicator helps to eliminate the noise, caused by the short-term price fluctuations.
Moving Averages can be used to identify price trends, as well as support and resistance levels. They are also used in the more complex indicators, like MACD and Ichimoku Cloud.
There are Simple Moving Averages (or SMA) and Exponential Moving Averages (EMA). In practice, they have denoted as [Type of Moving Average]+[Number of Periods the Moving Average Covers]. For example, SMA50 on a daily chart means a 50-day Simple Moving Average.
It is important to understand that the number in a moving average corresponds to a chosen time frame of your chart. That means, if you are looking at a chart with daily candles, each data point in SMA200 will be calculated from 200 days-worth of price data. However, if you are using the 4-hour candles, 200 will mean 200 4-hour periods, not 200 days. The same goes for hourly candles, monthly candles, weekly candles, etc.
Simple Moving Average is calculated as the arithmetic mean of the prices over a set period of time.
In other words, to calculate the SMA50 today on a daily chart, we would take the closing prices of the last 50 days, sum them up, and divide them by 50. Yesterday’s SMA50 would be the simple average of the previous 50 days’ closing prices.
As we keep shifting back one day, we will calculate the SMA50 for the previous days and get a graph that smoothes the price action.
The issue with SMA is that it weights all price points equally. As a result, the indicator is lagging, i.e. less responsive to the most recent price information, which is arguably more important.
Exponential Moving Average, in contrast, is calculated to give more weight to the most recent prices. As a result, it reflects the new information better than the Simple Moving Average.
If you are interested in the EMA calculation formula, you may search for articles on the internet. However, understanding that EMA is a weighted average by nature is sufficient to apply it in your chart analysis.
In CEX.IO Broker, you can use the built-in tools to add moving averages to your chart. Press the flask icon and search for SMA or EMA. Add the desired period in Length and you’ll see the indicators plotted on the chart like so:
Moving Averages convey information about the trend. Increasing moving averages mean the prices are generally rising. Decreasing moving averages imply the prices are generally declining.
Aside from signaling the trend direction, moving averages are also the indicators that analysts look at:
- To determine the levels of support and resistance;
- To find crossovers of the price chart with a moving average, up or down;
- To identify crossovers between the long-term and the short-term moving averages;
- As part of more complex technical analysis indicators.
If you want to understand how to read the Moving Average signals, check out this article: Moving Averages Crossovers and Trading Signals.