The moving average is considered to be one of the most popular financial market indicators out there. Traders like it because of its efficiency; even though it’s late to react to market conditions, it can still reveal hidden things that aren’t visible using just a simple chart.
Using a moving average indicator can help you see the support and resistance levels of any market you’re trading and spot what trend a market is in, whether bullish or bearish. Using an indicator while trading is excellent, but like most technical indicators, you shouldn’t take all your trade decisions based on information from one indicator; even though the moving averages are very efficient, they are not a 100% signal to take a trade.
One way to gain an edge in binary options trading is learning about technical indicators and how each one works and reacts to market conditions.
What is a Moving Average (MA)?
The moving average has a straightforward meaning that’s easy even for newbies to grasp. It is simply a way of graphing daily prices over a period of time.
It uses the daily closing price of a cryptocurrency or commodity as a data point averaged over a given period.
As new prices are added and plotted on the chart, the number on the moving average changes, which also causes the trend line to move.
Short-term moving averages will stay closer to the latest price than long-term ones. But long-term traders trust the value shown by long-term moving averages.
Is the Moving Average a good indicator?
The moving average is an important indicator used by all types of traders regardless of what market you’re trading but mainly depended on more by technical traders.
Moving averages are perfect for quite a several reasons. First of all, they are good at doing what they were designed to do. They plot price action graphs cleanly and eliminate all the noise on the chart. This can be useful when it comes to high volatility stocks like the ones I trade.
A smooth line moving average can also be helpful. It easily shows the support and resistance levels of a currency over a period. That is very valuable for your trading plan.
It can help you if you use it correctly. The bad side comes from misapplication.
Most financial market traders use the moving averages to identify market trends because, believe it or not; moving averages are capable of doing that perfectly. If the price crosses the moving average line on its upward path, it is an uptrend. If it crosses while going down? It’s a downtrend.
The major problem here is that some people see these trends as an indicator of future movements. People fail to realize that the indicator only reacts after the move has happened, meaning that it only reacts to past price movement and not the future.
If you depend too much on the moving average, you will always get a view on the market late, affecting the quality and precision of your trades.
Types of Moving Averages
What formula works for you?
Trading enthusiasts have spent their careers fine-tuning their moving averages. But traders usually use the three most basic moving averages.
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Weighted Moving Average (WMA)
The difference between these three moving averages is in the importance given to the most recent price change.
Simple moving averages handle all prices as of equal importance. Exponential moving averages, on the other hand, give more priority to recent price and price changes. Weighted moving averages also focus more on recent data but in a more uniform way.
Simple Moving Average (SMA)
A simple moving average calculates the average of specified prices in a time range.
For example, a 5-day Simple Moving Average takes the average of the last five days of a currency or token’s price. It gives you a picture of a currency’s recent price action, along with a perspective on its prospect and potential.
But this is not the way people use moving averages in today’s charting software. These days, a moving average shows periods rather than days.
If you are looking at a one-year chart with daily candles, your 5-period SMA could be a five-day SMA.
But if you are looking at a one-day chart with one-minute candles, your five-period SMA will be a five-minute SMA. See how much closer it gets to price action?
Make sense? We know it’s a bit of math.
Exponential Moving Average (EMA)
An exponential moving average gives more weight to recent changes in price. This is a good indicator because you are trying to trade now, not five days ago; you should, however, note that because it’s quick to react to price changes, there’s the danger of giving off a false signal.
Exponential Moving Averages use a multiplier to prioritize more recent periods. This is one of the interventions that are used to delay it a little less.
Simple vs. Exponential: Which Moving Average is Better?
Like the saying goes: different strokes for different folks
There are a few reasons why you might want to use a moving average in the first place.
Determining the price trend is more of a hands-on reason. Moving averages smoothen out the ups and downs of price movement. This can give you a more accurate description of a currency’s trend direction.
If you use a simple moving average, you risk missing out on an exploding market move. But an exponential moving average could be misleading about the currency’s long-term direction or potential.
Long-term directions are less important to intraday traders than they are to long-term traders.
They both can be used to identify support and resistance, although simple moving averages will present a better pictorial representation of historical support and resistance.
If you are trading a volatile market, commodity or currency, you may want to use exponential moving averages. Since they are more reactive to ups and downs, they may give you a better impression of what the market is doing.
So, which moving average is best? SMA or EMA? Both can be successfully applied in different situations, but here is a summary of each one to help you decide:
Simple Moving Average
You already know this is the slow-reacting average, very useful to confirm a trend rather than predict, which is very good if you’re considering long term trades, the downside is that you could miss on a precise entry if you depend on the simple moving average alone since it’s slow to react to changes.
Exponential Moving Average
Unlike the simple moving average, the EMA reacts and moves faster and places more importance on the most recent price changes. Very good for short-term trades where the most recent price data is the most relevant.