A moving average is a simple technical indicator that calculates the close price of an asset over a particular period of time. A moving average is used to identify the trend and simplify the price action. It can be used as a trend indicator.
A period can be defined as the time of one candle. For example, a 20 period moving average calculates the average close price of the last 20 candles.
A 200 MA can be used to identify the long-term trend. Similarly, a 20 MA can be used to identify the short-term trend. The most popular averages are: 20, 50, 100, and 200.
Uses of a Moving Average
The Moving Average has 3 main uses:
- Identify the Trend
- Identify a Trend Change
- Identify Areas of Support and Resistance
1. Identify the Trend
The moving average line is considered a trend indicator. It’s primary function is to help identify the trend of the price. This can be accomplished by three techniques:
Technique 1: Price Vs Moving Average
The location of the price compared to the moving average can help determine the trend of the market.
If the price candle is above the moving average line, then the price is considered to be in an uptrend. In this scenario, we need to look out for buying opportunities.
On the otherhand, if the price candle is below the moving average, then the price is considered to be in a downtrend and we should look for selling opportunities.
In sideways, or range-bound markets, the price does not stay above or below the moving average. It is best to not trade and wait for a clear trend to develop.
Two moving average lines can be used; one for short-term (20MA), and the other for long-term (200MA). Using two moving averages will not provide better trades, but will certainly help in avoiding bad trades.
Technique 2: Moving Average Slope
The slop of the moving avergae gives a hint about the strength of the trend.
A strong uptrend will show a steep slope (almost 45 degrees), while a weak uptrend will show a gentle upward slope. The same applies to downtrends.
Strong trends allows strong and aggreeesive entries, but care must be taken with weak uptrends.
Technique 3: Large Vs Small Moving Average
The trend in the market can also be identified by using two Moving Average lines; first line can be set to 50 (smaller MA), while the other to 200 (Larger MA).
When the Smaller MA is above the Larger MA, the price is considered to be in an uptrend and we need to look for buying opportunities.
On the other hand, when the Smaller MA is below the Larger MA, the price is considered to be in downtrend and we need to look for selling opportunities.
2. Identify a Trend Change
There are two techniques to identfy Trend Reversals/Changes.
Technique 1: Price Crossover
When the price crosses the MA from above, it indicates that the uptrend is over (bearish trend starts). Similarly, when the price crosses the MA from below, it indicates the downtrrend is over (bullish trend starts).
Not all croossovers are signals and many of them can be fake signals. It is recommended to reply on Moving Average Crossover.
Technique 2: Moving Average Price Crossover
The MA Crossover depends on two moving average indicators; (50MA and 200MA).
When the smaller MA line is above the larger MA line, this indicates an uptrend. Similarly, when the smaller MA line is below the larger MA line, this indicates a downtrend.
When the smaller MA crosses the larger MA from “above” it indicates that the price has shifted from an uptrend to downtrend (bearish). Similarly, when the smaller MA crosses the larger MA from “below” it indicates that the price has shifted from a downtrend to an uptrend (bullish).
3. Identify Areas of Support and Resistance
Support and Resistance usually refer to fixed price levels where the price is expected to reverse. The MA line can be used as a dynamic level of support and resistance.
In an uptrend, price stays above the moving average. When the price hits the MA line, it finds support (best for buying).
On the otherhand, in a downtrend, price stays below the moving average. When the price hits the MA line, it finds resistance (best for selling).
