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Understanding Moving Averages in Crypto Trading

Understanding Moving Averages in Crypto Trading

One of the most fundamental technical indicators, the basis of countless other more complex indicators, is the moving average. 

Moving averages show us the average price of an asset over time. We use them to uncover price trends and determine whether an asset is trading above or below its fair market value.

Key Terms Necessary for Understanding Moving Averages

 

  • Period: The number of time intervals used in the SMA calculation. For example, in SMA14, the period is 14.
  • Timeframe: The duration of each time interval, which can vary (e.g., minutes, hours, days).
  • Candle: A visualization of price movements within a specific timeframe. It shows the opening, closing, high, and low prices.
  • Weighting Multiplier: A ratio used to give more weight to recent prices when calculating Exponential Moving Averages (EMAs).

What Is a Simple Moving Average (SMA)?

The simplest type of moving average is, as the name suggests, the Simple Moving Average (SMA). 

The SMA has one main parameter: its period. The period is typically denoted by a number following the abbreviation SMA, such as SMA14. This means the indicator calculates the average price over the last 14 time intervals.

How to Calculate the SMA

To calculate the Simple Moving Average, we sum either the opening, closing, or an average of both the opening and closing prices of an asset for every candle in the defined period and divide by the number of periods. 

 

This is the Simple Moving Average formula

SMA = (Sum of closing prices over N periods) / N

 

What Is an Exponential Moving Average (EMA)?

The EMA is a time-weighted version of the moving average where time intervals closer to the present are given more importance in the final calculation. This makes the indicator sensitive to more recent price changes, which makes it particularly useful in trading as present market developments tend to dictate market dynamics more strongly than past ones.

 

Just like the SMA, the Exponential Moving Average has the period parameter but it also features an additional parameter — a weighting multiplier

How to Calculate the EMA

Working out the EMA is slightly less straightforward compared to calculating the SMA but we’ll guide you through the process. 

First, you need to calculate the SMA using the SMA formula. Then you calculate the weighting multiplier like so: 

k = 2 / (N periods + 1)

 

The EMA needs an initial reference value in order to work properly — the SMA. The first value in the series of values that will make up each time interval in your EMA will be the SMA. Then for every subsequent interval, you will apply the EMA formula like so: 

EMA = (Current Price * k) + (Yesterday’s EMA * (1 - k))

 

To calculate the EMA for every interval, the formula takes the asset’s price from that interval and gives it extra weight by multiplying it by the weighting multiplier. Then, yesterday’s EMA is multiplied by the remainder of the weighting multiplier (1 - k), and the two results are added together to produce today’s EMA. 

 

For example, for a 14-day EMA:

 

k = 2 / (14 + 1) = 0.1333

 

At the heart of the EMA formula is a process called exponential smoothing. Prices from further back in time have their influence on today’s EMA reduced exponentially because they are repeatedly multiplied by (1 - k) in each successive calculation. At the same time, today’s price is given greater weight in the calculation, which ensures that more recent prices have a more significant impact on the EMA. This combination of reducing the influence of older prices while emphasizing the latest price makes the EMA more responsive to recent price changes.

 

Trading Using Moving Averages

Moving averages provide a number of opportunities to better understand what’s going on on the price charts. They can be used to judge trends using ribbons and generate trading signals with cross-up and cross-down events.

What is a Moving Average Ribbon?

crypto chart with moving averages pumping

A Moving Average (MA) ribbon is a collection of Simple Moving Average or Exponential Moving Average indicators of different period lengths all displayed together on the price charts. It’s a handy tool that traders can easily configure on their own in order to better understand market dynamics. 

Ribbons can provide instant visual feedback about the strength of price trends. The more spaced out each line in the ribbon is, the more momentum a price move has and the bigger it is.

Cross-Ups & Cross-Downs

A cross-up is a technical event that happens when a shorter period Moving Average (MA) (applies to both EMA and SMA) crosses above a longer period MA. This is generally considered a bullish trading signal. 

 

One of the most famous signals in trading is the Golden Cross — the event of a 50-period MA moving above a 200-period MA. 

 

The cross-down event, on the other hand, is bearish and happens when shorter-term MAs cross below longer ones. 

The opposite of the famous Golden Cross is the Death Cross signal — the moment when the 50-period MA crosses below the longer 200-period MA. 

Conclusion

Traders can use moving averages and the signals they produce, when doing technical analysis, to better inform their trading strategies. Moving averages, especially the EMA are powerful tools when combined with other indicators tracking price trend momentum (e.g., the Relative Strength Index [RSI] and the Money-flow Index [MFI]). 

 

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