- Simple MAs provide a smooth chart (which prevents fake-outs) but is slow moving, causing delays when entering into a new trend.
- Exponential MAs provide a quick moving indicator (allowing you to get in on a trend early) but the chances of a fake-out are higher than with simple MAs.
- When the price crosses above (or below) a moving average, it is usually a signal to buy (or sell) that asset.
- Moving averages also offer dynamic support and resistance levels.
- The crossover of a shorter MA above or below a longer MA is used to provide an entry signal. For instance, the golden cross provides a signal to buy while the death cross provides a signal to sell.
Simple Moving Averages (SMAs)
A Simple Moving Average (SMA) is just the average of an asset’s closing price over a given period of time. For instance, the moving average that is most frequently looked at by traders is the 200-day moving average and the 50-day moving average.
A simple moving average can inform us of the current trend as well as providing support and resistance levels.
- If the price is above a moving average it suggests the asset is in an uptrend.
- Conversely, if the price is below a moving average it suggests the asset is in a downtrend.
As an example, consider the chart below showing the 50-day moving average for BTC-USD.
A break above the MA often predicts a change in the trend which happened with the price of bitcoin and broke above the MA in early 2019. Bitcoin rallied from a base of around $3,000 to a high of approximately $13,900 by the end of June. During this uptrend, the SMA acted as support (highlighted above).
However, in July the price of bitcoin broke below the SMA and the break of the moving average foreshadowed a fall in the value. In the downtrend, the MA acted as a dynamic resistance level, as BTC-USD touched the moving average twice in August and September but was rejected and sent lower.
We can also use Fibonacci numbers as the period for simple moving averages.
For example, the 50-day moving average didn't follow the price that closely as shown above. The pullbacks during the rally from $3,500 to $13,900 did not touch the 50-day MA. When putting the 34-day MA on the chart, we see that it provided better entry signals than the 50-day MA, as the price touched the 34-day MA several times on during the uptrend.
Exponential Moving Averages (EMAs)
An Exponential Moving Average (EMA) is slightly different to a simple moving average, as it places more weight on the more recent trading sessions.
Therefore, EMAs are more sensitive to price action than SMAs and can identify trends before a simple moving average. However, the earlier opportunities that EMAs provide come at a cost of a higher rate of fake signals.
The chart above shows the price action for BTC-USD along with the exponential moving average with a period of 21. In early September, the price broke above the EMA and the trend on the 4-hour chart turned bullish, with BTC-USD moving above $10,000. However, when the price broke below the EMA, the trend turned bearish, testing the $10,000 level again.
One word of warning: the price crossing the SMA or EMA is not a sure-fire entry signal. Often, if the price breaks a moving average, it will often return to it and test it as support or resistance. For example, in the chart above, we see that the price broke below the EMA but then rose to $10,800 and tested the moving average as resistance before continuing downwards.
Another way to use moving averages is to use two or more at the same time and look for crossovers. There are two crossovers traders should know about; the golden cross and the death cross.
The ‘Golden Cross’ is when a shorter moving average crosses above a longer moving average and typically refers to the 50- and 200-day moving averages. The Golden Cross signals that a rally might be about to start.
The Golden Cross is shown above for the 50-day and 20-day moving averages. The signal would have been given as bitcoin traded around $3,900 in late February. The price fell and tested the 20-day moving average, but held as support and bitcoin went on to rally to highs near $6,000 by May.
The ‘Death Cross’ is the opposite of a Golden Cross, where a shorter moving average (e.g., a 50-day MA) crosses below a longer moving average (e.g., the 200-day MA) and signals that a downward trend is about to start.
The Death Cross is shown above for BTC-USD. The 13-day moving average moved below the 21-day moving average as ether opened the day around $11,200. The shorter moving average diverged away from the longer moving average as BTC-USD continued its downward move and eventually reached lows near $9,000.
As with the price crossing the moving averages, the death cross and golden cross are more reliable if longer timeframes are used. Since faster moving averages will cross over each other more frequently, there is more likelihood that they will produce false signals.
Pi Cycle Top Indicator
A variant of moving average strategy was introduced by Philip Swift as a way of calling tops in the price of bitcoin.
The Pi Cycle Top indicator takes the 350-day moving average of bitcoin and multiplies the moving average price by two. Then the 111-day moving average is applied to the chart as well. When the 111-day moving average touches the 350-day moving average, it has historically indicated a top in bitcoin.
The Pi Cycle Top Indicator does produce signals that frequently, as the chart above shows just three signals were given in bitcoin's entire history. The advantage of this indicator is that it has called tops in the price of bitcoin to within three days.
Check out LookIntoBitcoin to find other variants of moving averages, such as the two-year moving average multiplier and 200-day moving average heat map.
Multiple Moving Averages
Multiple moving averages combines a number moving averages to highlight short-term and long-term trends. As with the Golden Cross or Death Cross, when the short-term moving averages moves above or below the long-term moving averages it indicates a new trend is forming.
The chart above shows how the Moving Average Multiple can be used to enter trades. Notice that the 13-, 21-, and 34-period moving averages moved above the 55-period moving average at the start of an upward move that saw bitcoin appreciate from $9,800 to a high of $10,944. Similarly, the shorter-term MAs crossed below the 55-period MA around $10,500 and bitcoin eventually fell to a low of $9,934.
The trend strength can be gauged by the separation between the short-term and long-term moving averages. If there is a wide separation, then the trend is strong while if there is little separation or the MAs are intertwined then the trend is fading and the price is consolidating. For instance, the chart below shows that the MAs expand as a trend gains momentum, but will start to converge again as the trend comes to an end.
Adjusting Moving Averages
You can adjust the moving average by clicking the options button (screw symbol) and change the period, the source of the moving average (default is closing price) and the offset.
A shorter length for the moving average is more suitable for lower timeframes (5 minutes or 15 minutes) whereas a longer length for the moving average is more suited to higher timeframes. You can always return to the default settings by clicking on ‘Default’ and then ‘Reset Settings’.
A few important moving averages for bitcoin are the 128-day, 200-day, 128-week and 200-week MAs, which have been important over BTC-USD's price history. For instance, a test of the 128-day and 200-day MA's is usually a sign to buy or sell for a short-term position, depending ont he position of the 128-day MA relative to the 200-day MA.
Similarly, the 128-week and 200-week MAs have highlighted good opportunities to buy bitcoin when the price has tested these levels.
In summary, moving averages are a widely-used trading indicator and are very versatile.
As explained above, you can use different combinations and variants of moving averages to produce different trading strategies. Moving averages can act as support and resistance and can also be used to identify entries.
A simple moving average crossover can give a signal to enter a position. The golden cross (most commonly an upward crossover of the the 50-day and 200-day moving average) provides an opportunity to buy while the death cross (a downward crossover of the 50-day and 200-day moving averages) provides an opportunity to sell.
Exponential moving averages place more weight on recent time periods and can help you to get in on a trend quicker than with simple moving averages. However, the downside is that you are likely to get more fake signals. There are other variants of moving averages, with just a couple of examples outlined in this guide, namely the multiple moving averages and the Pi Cycle Top Indicator.