Moving averages are one of the most widely used technical indicators. They smooth out price data to help identify trends and potential support/resistance levels. Here is how they work.
What is a Moving Average?
A moving average (MA) calculates the average price over a specific number of periods. As new data comes in, the oldest data drops off, so the average "moves" with price.
Simple concept: A 20-day moving average shows the average closing price of the last 20 days. It creates a smooth line that follows price.
Types of Moving Averages
Simple Moving Average (SMA)
Calculates the straight average of prices over a period. Each price point is weighted equally.
- Easy to understand and calculate
- Slower to react to price changes
- Good for identifying overall trend direction
Exponential Moving Average (EMA)
Gives more weight to recent prices. Reacts faster to price changes than SMA.
- More responsive to recent price action
- Better for short-term trading
- Can give more false signals in choppy markets
Common Moving Average Periods
- 9 or 10: Short-term, used for quick signals
- 20 or 21: Short-term trend, roughly one month
- 50: Medium-term trend, widely watched
- 100: Medium-term trend
- 200: Long-term trend, very widely watched
How to Use Moving Averages
1. Trend Identification
- Price above MA = bullish
- Price below MA = bearish
- MA sloping up = uptrend
- MA sloping down = downtrend
2. Support and Resistance
Moving averages often act as dynamic support/resistance levels. Price frequently bounces off key MAs like the 20, 50, or 200.
3. Crossovers
When a shorter MA crosses a longer MA:
- Golden cross: Short MA crosses above long MA. Bullish signal.
- Death cross: Short MA crosses below long MA. Bearish signal.
Golden Cross Example
The 50-day MA crosses above the 200-day MA.
This signals that the medium-term trend has turned bullish relative to the long-term trend.
Traders often see this as a buy signal, though it can lag.
Moving Average Strategies
MA Pullback Strategy
- Wait for price to be above the 20 EMA (uptrend)
- Wait for price to pull back to the 20 EMA
- Enter when price bounces off the MA
- Stop loss below the MA
MA Crossover Strategy
- Use two MAs (e.g., 9 EMA and 21 EMA)
- Buy when fast MA crosses above slow MA
- Sell when fast MA crosses below slow MA
- Works best in trending markets
Limitations of Moving Averages
- Lagging indicator: MAs follow price, they do not predict it
- Whipsaws: In choppy markets, price crosses MAs frequently giving false signals
- Does not work in ranges: Best in trending markets
Track Your MA-Based Trades
Pro Trader Dashboard helps you analyze which moving average strategies work best for you.
Summary
Moving averages smooth price data to show trends. SMAs weight all prices equally, EMAs emphasize recent prices. Use them to identify trends, find support/resistance, and generate signals with crossovers. Remember they lag price action and work best in trending markets.
Learn more: support and resistance and MACD indicator.