Beginner's Guide To Moving AveragesMoving averages are without a doubt the most popular trading tools. Moving averages are great if you know how to use them but most traders, however, make some fatal mistakes when it comes to trading with moving averages. In this article, I show you what you need to know when it comes to choosing the type and the length of the perfect moving average and how to use moving averages when making trading decisions.
What is the best moving average? EMA or SMA?
In the beginning, all traders ask the same questions, whether they should use the EMA (exponential moving average) or the SMA (simple/smoothed moving average). The differences between the two are usually subtle, but the choice of the moving average can make a big impact on your trading. Here is what you need to know:
The differences between EMA and SMA
There is really only one difference when it comes to EMA vs. SMA and its speed. The EMA moves much faster and it changes its direction earlier than the SMA. The EMA gives more weight to the most recent price action which means that when the price changes direction, the EMA recognizes this sooner, while the SMA takes longer to turn when the price turns.
Pros and cons – EMA vs SMA
There is no better or worse when it comes to EMA vs. SMA. The pros of the EMA are also its cons – let me explain what this means:
The EMA reacts faster when the price is changing direction, but this also means that the EMA is also more vulnerable when it comes to giving wrong signals too early. For example, when the price retraces lower during a rally, the EMA will start turning down immediately and it can signal a change in the direction way too early. The SMA moves much slower and it can keep you in trades longer when there are short-lived price movements and erratic behavior. But, of course, this also means that the SMA gets you in trades later than the EMA.
What is the best period setting?
When you are a short-term day trader, you need a fast-moving average that reacts to price changes immediately. That’s why it’s usually best for day traders to stick with EMAs.
On the other hand, Swing traders have a very different approach and they typically trade on higher time frames (4H, Daily +) and also hold trades for longer periods of time. Thus, swing traders should first choose an SMA and also use higher period moving averages to avoid noise and premature signals.
The best moving average periods for day-trading
9 or 10 periods: Very popular and extremely fast-moving. Often used as a directional filter (more later)
21 period: Medium-term and the most accurate moving average. Good when it comes to riding trends
50 period: Long-term moving average and best suited for identifying the longer-term direction
The best periods for swing trading
20 / 21 periods: The 21 moving average is my preferred choice when it comes to short-term swing trading. During trends, price respects it so well and it also signals trend shifts.
50 period: The 50 moving average is the standard swing-trading moving average and is very popular. Most traders use it to ride trends because it’s the ideal compromise between too short and too long term.
100 period: There is something about round numbers that attract traders and that definitely holds true when it comes to the 100 moving average. It works very well for support and resistance – especially on the daily and/or weekly time frame.
200 / 250 period: The same holds true for the 200 moving average. The 250 period moving average is popular on the daily chart since it describes one year of the price action (one year has roughly 250 trading days)
How to use moving averages
Trend direction and filter
you can use a fast EMA to stay on the right side of the market and filter out trades in the wrong direction. Just this one tip can already make a huge difference in your trading when you only start trading with the trend in the right direction.
The Golden Cross and the Death Cross
But even as swing traders, you can use moving averages as directional filters. The Golden and Death Cross is a signal that happens when the 200 and 50-period moving average cross and they are mainly used on the daily charts.
In the chart below, I marked the Golden and Death cross entries. Basically, you would enter short when the 50 crosses the 200 and enter long when the 50 crosses above the 200 period moving average. the screenshot shows that during the last bitcoin cycle if you stuck to the moving averages you would have been profitable most of the time both in the long and short directions. Also please notice how when the market is moving sideways it's not favorable to use the moving averages.
I will end this article here, I hope you now have a better understanding in moving averages and how to utilize them to follow the trend.
