Many technical analysis strategies are based on the Moving Average (MA) trend indicator. This indicator is shown as a line on a chart, showing the average value of assets over a period.
The key variable used with a moving average is the time period, and it will determine the number of values that are used in the calculation.
Depending on a trader’s trading strategy, they will chose at their own discretion the moving average type they want to use and the number of periods that should be used for smoothing. The number of periods is also known as the moving length, a window, or the construction period.
Constructing and analyzing a MA on Olymp Trade
When constructing and analyzing a moving average, one of several different stock prices can be used, including the closing price, the opening price, the minimum price, the maximum price, the weighted average price, or the average price. Traders however most often tend to use the closing price of the stock or exchange pair.
Although there are many different types of MA, in this article we’ll only discuss the two that are most often used on Olymp Trade’s platform:
- Simple moving average (SMA).
- Exponential moving average (EMA).
The moving averages shown in the image all use the default 10 periods.
The SMA and the EMA are different from each other in that they calculate the price average differently. This results in the different types of moving averages shown for the same period looking different.
What Moving Averages are Used For
- Moving averages can be used to determine a trend’s direction. If a moving average is falling, the trader sells their assets and when it is rising, it makes sense to buy the asset. If a MA is used in this way, exit and entry points in the market are usually determined by using another strategies, such as Sliding Averages that move faster.
- A MA’s downward reversal having a negative slope on a price chart is seen as a signal for the start of a downtrend. A MA’s upward reversal having a positive slope on the price chart is seen as a signal for the start of an uptrend.
- Moving Averages that use round periods, e.g. 50, 100, or 200, are most often used as dynamic resistance and support levels.
- Traders use moving averages to determine the up- and downtrends by looking if it points upwards or downwards in the period. A period of 100 and more is seen as long-term, a period between 50 and 100 is seen as medium-term, while a period of 50 or less is seen as short-term.
A possible signal of a trend reversal can be found by looking for the moments of the biggest discrepancy between two averages that use different parameters.
Disadvantages of using Moving Averages
When moving averages are used to trade with a trend, the entry point always experiences a lag and this may lead to a substantial part of the trend’s movement to be lost.
When moving averages are used in a flat market, this tends to give many false signals which could lead to losses.