Moving Average in Cryptocurrency Trading

Moving Average in Cryptocurrency Trading

Table of Contents

If you actively trade cryptocurrency, you know how important it is to find some reliable technical indicators. You might be tempted to think that the more sophisticated is the technical indicator, the better. However, it’s not always true. In fact, one of the most solid indicators is the moving average (MA). It is probably one of the first and most simple measures used to assess the state of a given market.

It has first been used for tracking the price of company shares, commodities, and foreign exchange currencies (forex). When online trading became popular among retail traders, especially in the forex and contracts for difference (CFDs) industry, moving averages have become an integral part of any chart.

The cryptocurrency market has adopted the MA and all its variations so that traders could better understand the state of a coin or token and smooth the price volatility.

Like any other technical indicator, MAs don’t predict the future price direction but simply help traders understand the true state of a market, which can lead to informed decisions that eventually might convert into profits. Such indicators are especially relevant in the emerging crypto space, which is still unpredictable and volatile.

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All varieties of MAs have one common goal – bring more clarity in the price action of a given cryptocurrency. This is achieved by smoothing volatility so that the larger context could be deciphered. MAs are part of a wider category of indicators called trend indicators because they use past data to create a clear picture of a trend. Despite the fact that they rely on past data, traders still use MAs to anticipate the future price of a cryptocurrency.

What Is a Moving Average and How Many Types Are There?

The moving average is simply the average closing price of a cryptocurrency during the last “x” number of periods, e.g. hours, days, weeks, etc. If you are on the daily chart and set the MA with period 20 on the price action, you will see the average daily close price of a period of 20 days. You can calculate it this way – you should add the close prices of the last 20 days, and then divide the sum by 20. On the chart, old data is replaced with new data. Thus, a 20-day average is indefinitely recalculated by adding the new day and dropping the 20th day as the price fluctuates.

Here is how it looks on the chart – the MA is the blue line:

20 Day Moving Average (MA) BTC/USD
Source: TradingView – 20 Day Moving Average (MA) BTC/USD

Here, we used the MA with the period or length 20, as in the example above. Usually, it’s written as MA 20. However, that input can be changed – the longer the period of the MA, the greater the lag behind the actual price. Conversely, the shorter the period, the closer is the MA to the current price, because it uses fewer data inputs to average the price. Thus, larger MAs are more reliable because they reduce more noise and show the actual long-term trend. Nevertheless, MAs are usually used in combination.

Here is an example of the chart with MA20 (blue) and MA100 (red):

Crypto Trading - 20 Day and 100 Day Moving Average (MA) BTC/USD
Source: TradingView – 20 Day and 100 Day Moving Average (MA) BTC/USD

If you pay attention to the price performance in June and July, the MA 20 suggests that we are in a bearish market, so it would make sense to sell Bitcoin. However, if we check MA 100, we can see that there is a lot of bullish support and traders who sell can actually go against the market.

Besides the number of periods, the price points can also be changed. Thus, instead of close prices, you can set open, highs, and lows.

There are many variations to MAs. In the examples above, I used the simple moving average (SMA) indicator, which is the standard version of the MA. Besides this, there are two more popular types of MAs – exponential moving averages (EMAs) and weighted moving averages (WMAs). Let’s discuss each one more in detail.

Exponential Moving Average (EMA)

As we mentioned, all data inputs in simple moving averages are weighted equally, regardless of how recently they came. Traders who think that newer data should play a bigger role in their decision-making can use exponential moving averages (EMAs).

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EMAs were designed to give more importance to recent inputs in an effort to make it more sensitive to newer price changes. To calculate an EMA, you should first figure out the simple moving average over a given period, and then calculate the multiplier called “smoothing factor.” Generally, it has the following formula: [2 ÷ (selected time period + 1)]. Thus, in the case of a 20-day MA, the multiplier result is [2/(20+1)] = 0.0952. Then we take this smoothing factor to calculate the EMA as follows:

EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier)

Here is how EMA 50 (red) looks on the chart compared to SMA 50 (blue):

Crypto Trading - 50 Day Simple Moving Average (SMA) and 50 Day Exponential Moving Average (EMA)  BTC/USD
Source: TradingView – 50 Day Simple Moving Average (SMA) and 50 Day Exponential Moving Average (EMA) BTC/USD

Even though both the SMA and EMA are used widely among cryptocurrency traders, the EMA is more sensitive to sudden price changes and trend reversals. Given that EMAs can anticipate price reversal much better than SMAs, they are often preferred by short-term or intraday traders. Indeed, it is very important to select the right type of moving average. For this, you should think about trading approach, strategy and targets.

Weighted Moving Average (WMA)

Another type of MA is the so-called weighted moving average (WMA). The WMA also gives more importance to recent price inputs, but it uses a different formula than the EMA. The WMA gives traders a weighted average of the last n prices, where the weighting reduces with each previous price.

WMA = (Price * weighting factor) + (Price previous period * weighting factor-1)

WMAs can have different weights based on the number of periods. In percentage terms, the most recent price would have the most influence. For example, if we want to calculate the WMA of four different prices, the latest price would weigh 40%, the previous one would have a weight of 30%, then 20% and 10%. These ratios are arbitrary, but they show how WMAs work. Unlike EMAs, WMAs may give way more importance to the latest price compared to the previous ones. Thus EMAs tend to be smoother.

However, while WMAs come by default with more weight on the last price, this type of moving averages is way more customizable than the SMA and the EMA. Thus, you can actually move the weight to give historical prices more importance.

Here is how a standard WMA (green) appears on the chart compared to EMA (red) and SMA (blue):

Crypto Trading - Weighted Moving Average (WMA) for 50 Day Simple Moving Average (SMA) and 50 Day Exponential Moving Average (EMA) BTC/USD
Source: TradingView – Weighted Moving Average (WMA) for 50 Day Simple Moving Average (SMA) and 50 Day Exponential Moving Average (EMA) BTC/USD

As you can see, the WMA tends to catch price reversal much sooner, being more sensitive than the EMA.

How to Use Moving Averages

It’s important to understand that all MAs, no matter how sensitive they are to price changes, have a certain period of lag because they simply follow the past prices and cannot anticipate the future price. The larger is the period of the MA, the larger the lag. Thus, a MA that reflects the past 200 days will respond way more slowly to new price changes compared to an MA that analyzes the past 20 days. This is because any new entry will have a smaller impact on the MA 200.

Both can work in your favor or against you – it all depends on the trading mentality. Larger periods of MAs would work best for long-term investors because they can ignore isolated price fluctuations. On the other side, short-term traders might prefer MAs with smaller data sets that are sensitive to recent price changes. Still, the short-term MAs would smooth out the noise as well.

All in all, if you are an active trader, you won’t rely on a single type of MAs. In fact, there are strategies that use MAs with two different lengths. We’ll discuss the basics of these strategies below.

Traditional markets, including the cryptocurrency space, commonly operate with MAs of 50, 100, and 200 days. The MA 50 and MA 200 are monitored constantly within the stock, forex, and cryptocurrency industries. If the price breaks above or below these MA lines, traders usually consider this as a significant signal to buy or sell. For the cryptocurrency market, these indicators are even more relevant. However, given the market’s high volatility, the MA parameters and strategies vary based on the trader’s risk appetite.

Also, it’s worth mentioning that while our examples are in terms of days, you can switch the timeframes as you like. For example, on the hourly chart, the MAs will represent the close prices after each hour. Intraday traders and scalpers would likely prefer to monitor how a cryptocurrency has performed during the last four or six hours instead of months, which makes sense considering their strategy. Moving averages can work with any timeframe and provide reliable data for better decision-making.

Crossover Signals

The most powerful signals provided by MAs are crossovers. Generally, a single MA line that goes up suggests an uptrend while a declining MA line shows a downtrend. Nevertheless, to obtain crossover signals, you should set at least two MAs on the chart. Combining shorter MAs with larger ones would help you better understand where to enter or exit the market.

A crossover signal is considered when two MAs crossover on the chart. The bullish signal is when the short-term MA intersects the long-term one from bottom to top, hinting to the beginning of an uptrend. This is also called a golden cross. Conversely, the bearish crossover is created when the short-term MA crosses below the long-term one. Cryptocurrency traders call it the death cross.

Here is how a golden cross and a death cross appear on the chart:

Crypto Trading - Crossing Single 50 Day Simple Moving Average (SMA) and 100 Day Simple Moving Average (SMA) BTC/USD
Source: TradingView – Crossing Single 50 Day Simple Moving Average (SMA) and 100 Day Simple Moving Average (SMA) BTC/USD

In this example, where used two simple moving averages – SMA 50 (blue) and SMA 100 (orange). In the first instance, the SMA 50 crosses the SMA 100 from bottom to top, and then a strong uptrend has formed, suggesting that the signal was reliable. In the second case, we have a bearish signal that suggests a downtrend following a reversal.

However, while these signals may often work, this is not necessarily a rule. Otherwise, every trader would be a millionaire. Nevertheless, these are some indicative hints to help traders find the best entry and exit points. The MAs can also be merged with oscillators and volume indicators, to assess the intensity of a trend and the overbought/oversold level.

One drawback of MAs is their lagging. Given that MAs are considered lagging indicators that rely on previous price data, their signals are often too late. For example, a golden cross would point to buy the cryptocurrency, but the signal may come only after a visible increase in price. Also, the lagging factor causes many false buy or sell signals, which can confuse traders.

The Finale Note

All in all, moving averages are simple but reliable technical analysis indicator. I would say they are the most popular indicator used by traders across all industries, including cryptocurrency. MAs help traders analyze price trends by leveraging past data, which provides them with great insights into the health of the market.

Still, you should not use MAs and their crossover signals alone but rather combine more TA indicators to keep away from fake signals. Think about checking the resistance and support lines and using oscillators. Even when opening a position based on the crossover signals, you can use risk management techniques like stop-loss and take-profit. Most cryptocurrency exchanges allow traders to set this type of orders.

Finally, moving averages are the basis for many other key TA indicators widely used by cryptocurrency traders, including Bollinger Bands and MACD.

The Bollinger Bands indicator consists of a centerline, which is an exponential moving average, and two price channels above and below it. The price channels are expanding or contracting as the price becomes volatile or calms down.

Elsewhere, the MACD, which is the abbreviation of Moving Average Convergence Divergence, is a trend-following momentum indicator that indicates the relationship between two MAs or a cryptocurrency. The MACD subtracts the 26-period EMA from the 12-period EMA. It represents a histogram below the chart.

Here is how the Bollinger Bands and MACD appear on the chart:

Crypto Trading - Bollinger Bands (BB) and Moving Average Convergence Divergence (MACD)
Source: TradingView – Bollinger Bands (BB) and Moving Average Convergence Divergence (MACD)

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