How to Use Moving Averages Effectively in Trading

Using technical indicators can be a game-changer in trading. The moving average (MA) is a widely used method for revealing prevailing and developing trends. They are important tools for traders.

However, most traders make some fatal mistakes when trading with moving averages, which can be avoided if you know what you're doing. Aside from spotting trends, MAs can also be used to locate key support and resistance zones.

Simple moving averages (SMAs) take the average price over a set period as their focus, while exponential moving averages (EMAs) give more importance to more recent prices and are thus the more popular MAs.

This guide explores how moving averages can be used effectively for crypto trading.

What is a Moving Average?

The Moving Average is a technical indicator that provides the average price of an asset over a set period. MA is one of the most frequently used indicators in trading due to its reliability and simplicity. A moving average is simply the average of a particular data set over a given period.

This data, in most cases, is represented by the closing prices of an asset for a certain period. To calculate a moving average you need a certain amount of previously acquired information. For instance, a five-day moving average requires five days' worth of data, and a 200-day moving average requires 200 days of data.

The main purpose of the MA tool is to “smooth” the information provided by a chart, defining the general trend of an asset. The MA line itself serves as an additional tool for confirming the direction of an asset’s price movement, and can also indicate a trend change. 

Types of Moving Average

There are several types of MA. In general, one doesn’t have to calculate the moving averages manually. The main priority is to understand the principle of choosing the best period for each trading situation. The most popular moving averages are:

Simple Moving Average (SMA)

This is the most basic moving average, which is a simple calculation of the average price of a set of values over a given period.

For instance, to calculate the SMA for a 20-day period, you need to take the closing prices of the last 20 candles on a 1-day chart and divide the result by 20.

Here is an example of how simple moving averages smooth out price movements. The chart below plots three different SMAs on a 1-day BTC/USDT chart. As you can see, the longer the period of the SMA, the more it lags behind the price.

Notice how the 62 SMA is further away from the current price than the 30 and 5 SMAs. This is because the 62 SMA adds up the closing prices of the last 62 periods and divides them by 62. The longer the SMA period, the slower the indicator reacts to price movement.

The SMAs on this chart show the general mood of the market at a given time. Here we can see that the pair is following an upward trend. Instead of just looking at the current market price, the moving averages give us a broader view and help estimate the general direction of the price movement.

Exponential Moving Average (EMA)

The Exponential Moving Average gives more weight to recent period prices while the SMA is calculated based on a representation of the average of all prices taken over a particular period.

The formula for the EMA is as follows:

EMA = closing price × the multiplier + EMA (previous day) × (1 – multiplier)

There are two moving averages on the 4-hour Bitcoin chart above (SMA 60 and EMA 60). Note that the red line (EMA 60) is closer to the price than the yellow line (SMA 60). At the same time, if the trend changes, EMA changes its direction more quickly than SMA does.

That is because the exponential moving average puts more weight into the latest candles, which allows you to “filter out” the fake signals provided by the SMA. For example, in case of a sharp collapse of an asset within a single candle, the SMA will continue to move in an upwards direction for some time, while the EMA will give an idea of the price reversal earlier.

Weighted Moving Average (WMA)

It gives even higher priority to recent periods than the exponential moving average (EMA) because it assigns linearly weighted values to ensure that the most recent prices have a greater impact on the indicator than older prices.

SMA vs EMA

If you want a moving average that reacts fairly quickly to price action, the short timeframe EMA is your best choice. It can help you catch new local trends very early, meaning you won’t miss out on a significant amount of potential profit when you open a trade. The downside of using the exponential moving average is that it often gives fake signals during asset consolidation periods.

The SMA, on the other hand, serves as a good confirmation of a trend movement and can save your deposit from numerous false signals. However, this type of indicator reacts to price action slower, so if you rely solely on the SMA you can miss a lot of potential profits by opening a trade late. 

When to Use SMA vs EMA

The longer the time period of a moving average, the slower it reacts to changes in price. If everything else remains equal, an EMA will have a closer correlation with price than an SMA.

Hence, the EMA is often thought to be better for day trading than for trading over longer periods. Its effectiveness in long-term trading is limited by the very features that make it useful in the first place.

Since the EMA tends to move with price more quickly than the SMA, it is often whipsawed, which makes it a bad signal for entering or leaving "slower" chart timeframes (such as the daily timeframe).

The SMA's slower lag helps to smooth price action over longer periods, making it a useful trend indicator that allows one to hold long positions when price is above the SMA and short positions when price is below the SMA.

So, SMA vs EMA, which one should you choose? The choice is up to you.

Many investors use multiple moving averages to get a clearer picture of the market. To determine the overall trend, they may use an SMA over a longer time frame and then use an EMA over a shorter time frame to determine when the right time to enter a trade.

Examples of Trades

So, let’s first look at defining a trend with the SMA. If the price is above the moving average, the asset is in an uptrend and often the SMA (as well as the EMA) can serve as a dynamic support.

For instance, a breakthrough and a retest of the SMA 60 on the Bitcoin 4H chart in the green zone and a drop below the SMA in the red zone.

A similar example is a drop below the SMA 28, the asset enters a local downtrend.

To avoid following false indicator signals, traders often draw several moving averages on the chart at once. If, in this case, the SMA based on a shorter period is above the longer timeframe SMA, the asset is in an uptrend. Notice how the lines are almost touching, confirming the up-trend (on the chart SMA 60 is marked yellow and SMA 30 is red).

Another way to use two SMAs is to enter a position as the lines cross. In the chart below, the SMA based on a shorter period crosses the longer timeframe SMA, indicating a change in trend (from an uptrend to a downtrend).

This gives the trader confirmation to open a short position. Moving averages are lagging indicators, so a position should be opened sometime after the signal. Remember, the lower the period, the shorter this time interval is.

During the current Bitcoin price rally, the SMA 200 on the 4H chart served as excellent dynamic support. The chart has touched and even briefly crossed the line several times, but over the past few months, all of these interactions have only provided an excellent signal for opening a long position.

Moving averages are just one of the tools that traders use to execute quality trades. That is, this indicator is best used in combination with horizontal support/resistance levels and trendlines.

Overview of EMA Trading Bot

An EMA trading bot is a common moving average trading bot. The bot assigns more weight to the latest closing prices of the EMA. So, the way the bot works will be influenced more by recent price levels.

An EMA trading bot can detect trends and reversals by trading automatically against the markets of the user’s choice. This moving average trading bot works using the EMA crossover strategy. Additional risk management tools are included in an EMA trading bot's arsenal. After setting the bot to trade on the markets of your choice, you can sit back and enjoy the profits from the effective EMA crossover strategy.

How an EMA Trading Bot Works

The EMA trading bot is an algorithmic tool that generates signals to buy and sell cryptocurrencies based on the intersection of moving averages. Users can set their stop-loss, take-profit, EMA (both long and short) line periods, and lot size.

The EMA trading bot's rules specify buy triggers when the fast EMA crosses the slow EMA from bottom to top and sell triggers when the fast EMA crosses the slow EMA from top to bottom. An EMA trading bot performs great when markets are trending, but it struggles in ranging markets.

The EMA trading bot from 3Commas comes equipped with resources that will guide you on how to activate the bot in just a few minutes. The resources will also show you how to configure the EMA trading bot for your favorite timeframes and markets.

Optimized Moving Average strategy on Trend

Understanding how to trade with the trend is essential for developing a successful trend trading strategy. Profiting from a sustained price movement is the goal of trend traders. A trader in a trending market needs to be on high alert for any signals of a potential reversal that could derail their trade.

Importance of a Trend-Following Strategy

There are several benefits of trading with the trend rather than against it. The main benefits of this method are:

• It can result in greater profits.
• The transaction costs in trend trading are lower.
• It is more efficient and saves time.

Trend Trading With Moving Averages

Most trend traders use trend-following systems they've developed rather than looking at charts manually. Technical indicators on the chart are one example of a setup that falls into this category. It is possible to do so with the assistance of several trend-following indicators, such as Moving Averages.

When looking for trends, simple and smoothed moving averages perform the best. To analyze trends, a trader can choose from a variety of MA periods. Traders typically rely on the 200-period simple moving average. It reveals the directional bias of the market.

It is simple to implement a 200-period simple moving average. Buying pressure is present if the price is rising higher than the moving average. When prices, on the other hand, fall below the 200-period simple moving average, a downward trend is almost certain to start.

The chart above shows that when price was trading above the moving average, it was forming higher highs and higher lows. When it was trading below the moving average, however, it was making lower lows and lower peaks.

Optimized RSI Strategy For Reversals

It's no surprise that the RSI is the most popular momentum indicator given the many benefits it provides, especially in ranging markets. It's also easier to understand because it's constrained to a range from 0 to 100.

Due to its widespread use, the RSI can influence market prices as traders and portfolio managers act in response to the indicator's signals.

Values below 30 on the RSI are typically used to identify good buying opportunities. You could get stuck in a losing trade if the RSI stays in oversold territory for an extended period. It makes sense to hold off until the trend reversal is confirmed.

You can get favorable trading conditions by combining a low RSI reading (below 40) with a short-term moving average (in this case, MA9. 

Automate Your Moving Average Trading Strategies with 3Commas Moving Average Trading Bot

Many traders rely on moving averages for trading. The problem is, as with almost all indicators, if you want to trade in a short time frame, you will almost certainly miss the exact right time to execute the trade.

There are a few advantages to automating the entry of these trades. You don't have to sit in front of a screen or be constantly connected to your phone to receive alerts from your broker. Imagine investing a lot of time and effort to learn the market and develop a strategy, only to miss the buy signal when your conditions are met.

Moving average trading bots can help you find trending assets and you can then automate the entry process using different moving averages.

With 3Commas moving average trading bot, you can automate your trading strategies and never miss a chance to make money.

Conclusion

The moving average is widely used among cryptocurrency traders because of its versatility and flexibility. Apart from this, it is also a useful tool for determining the trend's direction and, by extension, which side of the trade to take. The moving average can also help in spotting oversold and overbought regions, thereby predicting rallies and corrections.

Moving averages based on a longer time frame are smoother than the ones with a shorter period as their base. Using an exponential moving average can help you identify trends faster, but it often produces a lot of false signals.

Simple moving averages are slower to react to price action but will keep you away from rushing into opening a position. However, they can hold you back from making a trade, and lead to missing out on potential profits.

We hope this blog has provided valuable insights into using moving averages (MAs) effectively in cryptocurrency trading. The article introduces MAs, their types (Simple Moving Average, Exponential Moving Average, and Weighted Moving Average), and discusses the advantages and disadvantages of each. It also explores how traders can use MAs to identify trends, support and resistance levels, and potential entry and exit points. Additionally, the article touches upon the use of EMA trading bots and trend-following strategies with MAs.

In conclusion, the use of moving averages is a crucial aspect of cryptocurrency trading in 2023. These technical indicators offer traders valuable insights into market trends and can assist in making informed trading decisions. Whether one prefers the responsiveness of Exponential Moving Averages or the stability of Simple Moving Averages, understanding the nuances of each type is essential for success in the ever-changing cryptocurrency market.

Moreover, the article emphasizes the importance of combining moving averages with other technical analysis tools, such as support/resistance levels and trendlines, for a comprehensive trading strategy. Additionally, the use of trading bots, particularly EMA-based bots, can automate trading processes and help traders capitalize on market opportunities efficiently.

As the cryptocurrency market continues to evolve in 2023, traders who master the art of using moving averages effectively will have a valuable edge in navigating the dynamic and often volatile landscape of digital assets.