What are Moving Averages in Trading? – Trading Essentials

eToro: Overall Best Stock App with 0% Commission

VISIT ETORO

X

Your capital is at risk. Other fees apply. For more information, visit etoro.com/trading/fees. 

The use of moving averages to analyze prices is prevalent among technical traders. Indicators like these often form the basis of traders’ charts, either as standalone metrics or in conjunction with others.

To take advantage of it, find out more about moving averages in trading by checking out our “What are moving averages in trading?” article.

What are Moving Averages? – Introduction

Definition and basic concept of moving averages

In the trading world, moving averages (MAs) are essential tools that smooth out price data to spot trends and reversals. They calculate an asset’s average price over a specified period. The Simple Moving Average (SMA) gives equal weight to all data points, whereas the Exponential Moving Average (EMA) emphasizes recent prices.

MAs are used to identify trends, support, resistance levels, crossovers and filter the noise on the market. Moving averages are popularly used in stock trading. So be sure to start with one of the best stock apps on the market.

How moving averages are calculated and their significance in trading

The moving average (MA) is calculated by averaging the prices of an asset over a specific period, with the oldest price dropping as new information becomes available. Using moving averages in trading assists in identifying trends, potential reversal points, dynamic support, and resistance levels and producing buy and sell signals.

By smoothing out price fluctuations, they aid traders in making informed decisions and reduce noise by providing a clearer view of the market’s direction. The cryptocurrency market is also involved in the use of the moving average; traders use it to identify price trends and, in that way, invest in the best crypto presales.

 Your capital is at risk.

Types of Moving Averages

Simple Moving Average (SMA)

SMA is calculated by summing up prices over a specified number of periods then dividing by that number. Identifying trends and reversals is straightforward because each data point is weighted equally. It provides clear historical price averages and is widely used because of its simplicity.

Exponential Moving Average (EMA)

In an exponential moving average, recent prices are given more weight, so it is more responsive to changes in the market. An algorithm emphasizes the most recent data points, giving them greater significance while gradually diminishing the significance of older data points.

Weighted Moving Average (WMA)

Different data points within a given timeframe are assigned different weights in a Weighted Moving Average. As a result, not all prices influence the average equally; rather, traders can attach greater weight to recent prices or other specific data points. By focusing on particular periods more than others, WMAs allow traders to analyze trends and patterns more effectively, which is useful when capturing short-term market movements. Commodities are popular in the MA type. Be sure to apply it in one of the best commodity apps to make informed decisions.

Moving Average Crossover Strategy

Definition and explanation of moving average crossovers

Whenever the long-term moving average intersects with the short-term moving average on a chart, then the crossover of moving averages has occurred. Bullish crossovers happen as soon as the short-term moving average crosses above the long-term moving average. It indicates a possible upward trend.

On the other hand, Bearish crossovers occur when short-term moving averages cross below long-term moving averages, indicating a possible downtrend. Market crossovers provide signals for buying or selling, as well as confirmation of potential changes in trend.

Using moving average crossovers to identify trend reversals and entry/exit points

Watch short-term and long-term moving average interactions for trend reversals and entry/exit points. An uptrend is indicated when the short-term moving average crosses over the long-term moving average, indicating a potential buying opportunity. In contrast, a bearish crossover indicates a potential downtrend or a signal to consider selling or exiting a position if the short-term moving average crosses below the long-term moving average.

Confirm crossovers with other indicators to get more reliable signals if the market is choppy.

Golden Cross and Death Cross

Definition and significance of the Golden Cross

On a price chart, the Golden Cross is identified by crossing a short-term moving average (50-day) above a longer-term moving average (200-day). Traders often consider it a strong buy signal, signaling a potential shift towards an uptrend.

Definition and significance of the Death Cross

Unlike the Golden Cross, the Death Cross is a bearish technical pattern. On a price chart, it’s when a short-term moving average, like the 50-day, crosses below a long-term moving average, like the 200-day. Traders typically view this as a significant sell signal in the event of a possible downtrend shift.

Examples of Golden Cross and Death Cross in real-world trading

Golden Cross Example:

There was a Golden Cross in the S&P 500 Index in early 2020. Indicating a potential shift from a downtrend to an uptrend, the 50-day moving average crossed above the 200-day moving average. This occurred after the COVID-19 pandemic caused a decline in the market. Market traders viewed the Golden Cross as a positive signal, and the market began to recover.

Death Cross Example:

During 2018, Bitcoin’s price chart showed a Death Cross, with the 50-day MA crossing below the 200-day MA, signaling the potential for a downtrend. After this, the cryptocurrency market experienced an extended period of price declines. As a result, the Death Cross was considered a confirmation of bearish sentiment.

 Your capital is at risk.

Moving Averages as Support

How moving averages act as support levels in an uptrend

Moving averages can act as support levels during an uptrend. An asset’s price usually finds support at the moving average when it pulls back or dips, preventing further decline and possibly rebounding. Observing this interaction identifies Trading opportunities and potential trend continuation points.

Identifying potential buying opportunities near moving average support

Watch for retracements or pullbacks towards moving average support to identify potential buying opportunities. Indicators such as candlestick patterns, bullish price formations, or oversold conditions may indicate price stabilization or reversal. Consider entering a long position when the price bounces off the moving average support or holds above it, aligned with prevailing uptrends.

Moving Averages as Resistance

How moving averages act as resistance levels in a downtrend

A moving average can serve as a resistance level during a downtrend. In the event of a rally or bounce in the price of an asset, resistance at the moving average often prevents any further upward movement, possibly resulting in a continuation of the downtrend. The interaction allows traders to identify selling opportunities or possible trend continuations.

Identifying potential selling opportunities near moving average resistance

Observe price rallies toward the moving average. Look for indications that the price may be stalling or reversing, such as bearish candlestick patterns, chart formations, or overbought conditions indicated by other technical indicators. Short positions should be considered when the price shows signs of turning down or struggling to rise above the moving average resistance.

Trend-Following with Moving Averages

Using moving averages to determine the direction of the trend

Moving averages can determine a trend’s direction by observing their relative positioning to price action. It indicates an uptrend whenever prices consistently rise above a moving average, such as the 50-day or 200-day moving average. In other words, moving averages serve as support levels, reflecting average prices over a given period. The moving average acts as resistance when the price consistently stays below it, indicating a downtrend.

It is also possible to determine the strength of a trend by examining the slope of the moving average. In the case of a rising moving average, it indicates a bullish trend, whereas, in the case of a falling moving average, it indicates a bearish trend. Further validation of the trend direction can be achieved by comparing shorter-term moving averages with longer-term ones, particularly by a crossover between the 50-day and 200-day moving averages.

Combining multiple moving averages for stronger trend signals

Multiple moving averages can provide stronger trend signals by smoothing out noise and confirming trend direction. Here’s how to combine two or more moving averages with different time periods:

• Dual Moving Average Strategy: Use a combination of a short-term moving average (e.g., 20-day) and a longer-term moving average (e.g., 50-day or 200-day). If the short-term MA crosses above the long-term MA, it generates a bullish signal that indicates the possibility of an uptrend. Alternatively, when the short-term moving average crosses below the long-term moving average, a potential downtrend is indicated.
• Triple Moving Average Strategy: Three different moving averages are utilized in this approach. An example would be a 10-day, 50-day, and 200-day moving average. Short-term moving averages crossing above medium-term and long-term moving averages provide a bullish signal. However, the bearish signal becomes more robust when the short-term moving average crosses below both the medium and long-term moving averages.

Moving Averages for Range-Bound Markets

How to identify range-bound markets using moving averages

Using moving averages to identify range-bound markets requires observing how prices interact with moving averages. Here’s how you can do it:

• Flattened Moving Averages: The market is considered range-bound when the price moves sideways without a clear trend. It is common for moving averages to flatten out during these periods, indicating a lack of a strong trend. Identify instances in which multiple moving averages are relatively flat and closely correlated, such as the 20-day, 50-day, and 200-day. It may indicate a range-bound environment due to a lack of significant trend momentum.
• Price Oscillation: Prices tend to oscillate between support and resistance levels in range-bound markets. Observe the interaction between the price and the moving averages. Range-bound conditions are evident when the price consistently bounces off a lower moving average (potential support) and faces resistance around a higher moving average.
• Moving Average Crosses: Moving average crossovers may occur frequently in a range-bound market, causing false signals. There may be a decrease in the reliability of crossovers during these periods. For identifying a lack of sustained trend movement, look at the slope and proximity of the moving averages.
• Volatility Contraction: Range-bound markets usually exhibit lower volatility than trending markets. An indicator such as Bollinger Bands can be used to determine if the price is contracting within a narrower range.

Strategies for trading within a range using moving averages

Utilizing moving averages within a range allows traders to capitalize on price oscillations between support and resistance levels. Consider these strategies:

• Mean Reversion Strategy: Consider selling if the price approaches the moving average’s upper range (resistance), anticipating a pullback toward the moving average’s lower range (support). Alternatively, if the price approaches the lower moving average, you may consider buying or going long, anticipating a bounce back toward the upper moving average. In this strategy, the price is assumed to return to the mean (moving average) after reaching an extreme level.
• Moving Average Crossovers within the Range: Using shorter-term moving averages (10-day and 20-day) can provide buying signals when prices cross above the lower moving average and sell signals when they cross below the upper moving average. With crossovers occurring within the range, trading opportunities arise without reversing the trend.
• Moving Average Bands: A “band” around the price can be created by applying multiple moving averages of different periods instead of a single moving average. If the price dips below the lower band, buy and sell if it rises. The strategy minimizes the impact of sudden spikes and drops while capturing price movements.
• Volatility-Adjusted Strategies: Bollinger Bands or Average True Range (ATR) are good volatility indicators to combine with moving averages. A trade should be entered when the price reaches the outer band or the volatility-adjusted level. This approach considers breakout or breakdown points despite the market’s range-bound nature.
• Support and Resistance Confirmation: Moving averages can be combined with other tools like horizontal levels and trendlines to provide support and resistance. If a price reversal is likely within the range, initiate trades when it approaches a moving average while aligning with other supports or resistance areas.

 Your capital is at risk.

Moving Averages with Other Technical Indicators

Combining moving averages with oscillators

Moving averages are combined with oscillators such as Moving Average Convergence Divergence (MACD) or the Relative Strength Index (RSI) to enhance trading signals and provide deeper insights into market conditions.

RSI with Moving Averages:

• Divergence Confirmation: Keep an eye out for divergence between RSI and price trend and cross the RSI’s moving average. This may indicate the possibility of a trend reversal. In the case of an upward crossing of the RSI’s moving average, it can be viewed as a bullish entry signal.
• Overbought/Oversold Validation: If the price is near a moving average resistance, consider selling or shorting if the RSI reaches overbought levels (typically above 70). Consider buying if the price is near moving average support in oversold conditions (typically below 30).

MACD with Moving Averages:

• MACD Line Crossovers: You may combine the MACD line (the difference between the short-term and long-term moving averages) with the signal line (the exponential moving average of the MACD line). Buy whenever MACD crosses above the signal line, and the price is above a relevant moving average. Whenever the MACD line crosses below the signal line and the price falls below a relevant moving average, it is a good time to sell.
• Histogram Patterns: You can determine the difference between the MACD line and the signal line using the histogram. Look for changes in histogram bars around moving averages. Histogram bars near support or resistance can indicate a potential bullish or bearish reversal, respectively.

Enhancing trading signals with moving average-based indicators

Utilize complementary tools to enhance moving average-based trading signals. Verify potential trend shifts with multiple indicators, like RSI or MACD. You can strengthen your trading decisions by looking for alignments among various indicators. Look for divergences between indicators and price movements that may indicate reversals.

To determine when to enter or exit, use moving average slopes, distances, and momentum indicators. For accurate signals, adjust indicator parameters according to market volatility.

Moving Averages for Risk Management

Using moving averages to set stop-loss levels

Use moving averages to determine stop-loss levels in uptrends and above-moving average resistance in downtrends. As a result, you can expect minor price fluctuations while protecting your position from significant losses.

Adjusting position size based on moving average signals

Adjusting position size based on moving average signals involves aligning your trade size with the trend’s strength indicated by the moving averages. In a strong uptrend, where the price is consistently above a rising moving average, you might consider increasing your position size as this indicates a higher probability of price continuation. Conversely, you might decrease your position size or avoid trading altogether in a strong downtrend where the price remains below a declining moving average. This approach helps you capitalize on trends while reducing risk during potentially adverse conditions.

Using moving average signals to adjust position size involves aligning your trade size with the strength of the indicated trend. A strong uptrend indicates a greater probability of price continuation, so you might consider increasing your position size in such cases. In contrast, you may decrease your position size or avoid trading entirely if the price remains below a declining moving average. You can take advantage of trends while reducing risk during potentially adverse conditions.

A moving average crossover can also be used to fine-tune the size of your positions. It is possible that you may increase the size of your position when a bullish crossover occurs (short-term MA crosses above long-term MA) if other factors are aligned, as this suggests a potential uptrend. If a bearish crossover (short-term MA crossing below long-term MA), you may wish to reduce your position size or avoid trading until the market stabilizes. Trading with moving averages optimizes risk management and increases your profits.

 Your capital is at risk.

Trading with Moving Averages – eToro Complete Guide

Having said that, let’s explore how we can get started using a trading app. Here is how we do this with eToro, a top-rated provider offering commission-free trading across thousands of markets worldwide.

Step 1: Open an Account and Upload ID

On the eToro website, you can sign up by clicking the ‘Join Now‘ button. As part of your registration, you must provide your full name, nationality, birth date, address, email address, and phone number.

Step 2: Confirm Identity

Withdrawals can only be made after your identity has been verified. Documents you must upload are listed below:

• Passport or driver’s license
• Utility bills or bank statements for the past three months

If eToro validates the documents automatically, your account should be verified instantly.

Step 3: Deposit Funds

Now that you have created your eToro account, you must locate it. Several convenient payment methods are available, including:

• Debit cards
• Credit cards
• E-wallets (Paypal, Skrill, or Neteller)
• Bank transfer

To trade on eToro, you must deposit at least $10. eToro is also one of the best paper trading apps. Give it a try before starting to trade.

Step 4: Browse Supported Trading Markets

As soon as you have funded your eToro account, all left to do is find the asset you are interested in trading. Choose a market that interests you.

Click the ‘Trade Markets’ button for a list of supported assets. Stocks, cryptocurrencies, forex, commodities, and eToro is also the best ETF app. All these assets will be available for trading.

Step 5: Place a Trade

You are now ready to place an order for the asset you wish to trade.

What are Moving Averages in Trading – Conclusion

A moving average is valuable for identifying trends, potential reversals, and entry/exit signals. By smoothing out price fluctuations, they enhance the ability to make informed decisions amid market noise. Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) are widely used by traders to examine trend direction quickly. In addition to moving averages, traders can use oscillators to enhance their signals and gain a deeper understanding of market conditions, enabling better trading decisions. With moving averages, traders can identify trends through crossovers while providing dynamic support and resistance levels to optimize their risk-reward ratios and chances for profit increase.

There are, however, some limitations to moving averages. When markets consolidate or change rapidly, they can generate false signals, resulting in losses. Moving averages can delay signals in fast-moving markets because they are lagging indicators. Furthermore, they might be less effective in short-lived or choppy market conditions. Trading strategies such as stop-loss orders and considering the broader market context effectively mitigate these drawbacks. As a result, traders familiar with the benefits and limitations of moving averages can utilize them effectively as part of a comprehensive trading strategy, enhancing their opportunities for success.

 Your capital is at risk.

FAQs