A moving average is one of the most common technical indicators. It is used to smooth out price data by creating a constantly updated average price line.
A moving average is a lagging indicator, which means trend-following because it is calculated using past prices. For example, a 7-day moving average is the average price trend based on 7 days of price data. A 200-day moving average requires 200 days of price data etc.
It is called a ‘moving’ average because the line is always moving with the addition of new data.
Types of Moving Averages
When a trader simply says ‘Moving Average’, they are referring to the Simple Moving Average. However, there are a few different variations of moving averages. Each uses a different formula to calculate the moving average line.
- Simple Moving Average
- Exponential Moving Average
- Weighted Moving Average
- Double Exponential Moving Average
- Triple Exponential Moving Average
- Linear Regression (Least Square Moving Average)
How to use a Moving Average?
A moving average can be used in technical analysis as a point of both resistance and support. Often the price will respect these levels as a point of price reversal.
It can also be used to generate buy or sell signals where prices intersect or cross over moving average lines. For example:
- If the price crosses above a moving average, it could indicate a buy signal and the start of an upward trend.
- If the price crosses below a moving average, it could indicate a sell signal and the start of a downward trend.
As always with price data, the larger the moving average, the more significance, and importance it should hold. For example, a 50-day moving average shows a larger trend macro trend over a 7-day moving average. A 200-day moving average shows a larger macro trend over a 50-day moving average etc.
Using Multiple Moving Averages
A ‘golden cross’ occurs when a smaller moving average crosses above a larger moving average, indicating the potential start of an upward price trend. Similarly, a ‘death cross’ occurs when a larger moving average crosses above a smaller moving average, indicating the potential start of a downward price trend.
When a bull market is in full swing, all moving averages will be layered correctly – smallest on the top to largest on the bottom). Likewise, in a full-swing bear market, the largest moving averages will be on the top with the smallest on the bottom.
