Technical analysis: understanding moving averages

A moving average is a line on a chart that smoothes price data. There are two main types of moving average: the simple moving average (SMA), which takes the arithmetic average of a given set of prices over a specified number of periods in the past, and the exponential moving average (EMA), which is an average weighted average that gives more importance to the price in more recent periods, thus making it more responsive to new data.

Like any other indicator, it lags because it is based on past price data. Thus, the longer the period, such as the famous 200-day moving average, the greater the shift. You can choose the period you prefer; however the most used moving averages are the 50, 100 and 200 day moving averages.

SMA 50 days (blue), SMA 100 days (yellow) and SMA 200 days (red)

Moving averages are typically used to identify the trend direction of an asset or to determine its support and resistance levels. To identify the direction of the trend, traders look at where the short-term moving average is compared to the long-term moving average.

If the short period moving average is lower than the long period moving average, then it is a downtrend. If the short-term moving average is higher than the long-term moving average, it is an uptrend. Traders also like to see all moving averages move to one side or the other first to confirm the trend and avoid false signals.

moving average

Moving averages signaling trend changes

The best-known crosses are “the golden cross” and “the cross of death”. The golden cross is when the 50-day moving average crosses the 200-day moving average on the upside, confirming an uptrend. The death cross occurs when the 50-day moving average crosses the 200-day moving average on the downside, signaling a downtrend.

moving average

The Golden Cross and the Cross of Death

The other way to use the moving average is as a dynamic support or resistance. Price rarely follows a straight line, in fact there are usually pullbacks during a trend that follows the normal ebb and flow of the market.

These pullbacks can bounce off moving averages, and a trader can structure entries from those same moving averages in anticipation of a continuation of the previous trend and limit risk by placing stop losses some distance behind them. Below, you can see how the 50 and 100 day moving average served as support for the S&P500.

moving average

50 and 100 day moving averages serving as support

Don’t use moving averages alone for your trading decisions, but always have a fundamental view first for direction, then a technical structure if you need it for entries and exits.

This article was written by Giuseppe Dellamotta.


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