DLIVE - Technical Analysis 101 (Part 3): Moving Averages (SMAs & EMAs)
Technical analysis tutorial for beginners! This introduction to technical analysis will show you how to apply TA charting methods to crypto. Today I'll cover moving averages: simple moving average (MA or SMA) & exponential moving average (EMA).
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Today I’d like to talk to you about moving averages (or MAs for short). Like many other indicators such as RSI or MACD, moving averages are what’s known as a “lagging indicator” because their calculations are based on past prices. There are two types of moving averages you should be aware of: the simple moving average (abbreviated by either MA or SMA) and the exponential moving average (or EMA). Both types are used by traders to identify a trend direction, confirm a trend reversal, and also determine good support & resistance levels. Even though they’re calculated with drastically different formulas (which you can find details about by searching online), their values are determined based on the closing price of past candlesticks. A 10-day MA, for example, is a simple moving average calculated based on the closing price of the past 10 days, while a 26-day EMA is an exponential moving average whose calculations are based on the closing price of the past 26 days. The longer the time frame you select on your moving average, the greater the lag; meaning the slower it’ll react in relation to price. So you’ll find that shorter timeframes--such as the 8-day EMA or 13-day MA--react much faster & thus, can be seen as “hugging” price more closely on the graph. You’ll oftentimes see traders plotting two or more moving averages covering several time frames. They’ll do this because the moment they see the shorter timeframe moving average cross above the longer timeframe moving average, they’ll interpret this as a bullish signal & buy. The opposite can be done when it crosses below: it’s a bearish signal so you may want to sell. This is why I said earlier that moving averages can be used to confirm trend reversals. Now there are some key differences & characteristics that distinguish the simple moving average from the exponential moving average. Let’s start with the simple moving average. The simple moving average is--like its name suggests--simpler to calculate than the exponential moving average. You can use the SMA to filter out the “noise” you see on a graph in order to easily identify whether the coin is in an uptrend or downtrend. As I said earlier, you can also use the SMA of two different time frames to signal a trend reversal. One such example is called the “death cross,” which is when the 50-day SMA crosses below the 200-day SMA. This may signal to you that price may fall even further in the near future. The opposite of the “death cross” is the “golden cross.” Let’s take a look at some charts. Looking at Bitcoin’s 1-day chart, I’ve plotted six different simple moving averages from as low as 9 days all the way up to 200 days (whose values & colors are represented here). Let’s hide everything but the 9-day & 128-day MAs. You’ll see that the moving average for the 9-day MA sticks closer to price since it reacts faster over a shorter time frame. Conversely, the 128-day MA is calculated over a larger time frame and thus, appears smoother albeit with more lag. Now let’s take a look at the 50-day & 200-day MAs. You’ll see here that the 50-day MA (being the shorter timeframe of the two) crossed below the 200-day MA on March 29th, 2018. This is an example of the “death cross” that I was explaining earlier, and can be interpreted as a bearish signal. The exponential moving average is more formally known as the exponentially weighted moving average due to the fact that more weight is given to the more recent data during its calculations. Because of this, the EMA tends to react faster than the SMA and thus, can be more useful when looking for a good price to buy. Its faster reaction & tendency to “hug” price gives you an earlier entry signal that’s closer to the optimal point of market entry. Traders making moves over long time periods can use longer timeframe EMAs & the direction in which they’re pointing to identify the strength of a trend, which I’ll go over in more detail with you shortly using a chart. As with all moving averages, EMAs work well during strong trends. In an uptrend, you can use the EMA as a dynamic area of support, while in a downtrend, you can use it as a dynamic area of resistance. In addition, price crossing an EMA can act as either a bullish or bearish signal. But as always, do not use moving averages alone when making your trading decisions but rather, in conjunction with other indicators to help you confirm or justify your decisions. Now let’s get back to the charts. Here I’ve plotted for you six different EMAs on Ether’s 1-day chart (whose value & colors are represented here). But let’s display only the 100-day EMA alongside the 100-day MA. You’ll see here that the EMA reacts faster than the MA (which may appear more laggy) due to the fact that more weight is given to the more recent days when making its calculations. Now getting rid of both these moving averages & using the 50-day EMA, let me show you how to use the direction that EMA is pointing in order to identify trend strength (as I told you I’d do earlier). We can see that the EMA started turning downwards in early February of 2018. This can be interpreted such that the upwards trend is no longer very strong & that we may start seeing a trend reversal very soon; so this would be a good time to sell whatever Ether you have. As we can see, price did drop pretty significantly over the course of the next couple months. It’s important to note once more though, that since this is a lagging indicator, this signal is delayed & that selling during this time is nowhere near the optimal point of market exit (aka “selling at the top”). Lastly, I’d like to pull up the 21-day EMA. We can see that during Ether’s strong uptrend in late 2017/early 2018, the EMA acted as a strong level of support that was respected pretty well, since every time price touched it, it bounced right back up; rarely dipping below & not staying there very long if it did. We can also see during its strong downtrend in February & March of 2018 that the EMA conversely acted as a strong level of resistance where price either touched it & was shot back down or tested it by breaking above before being pulled back down once more. We can also see in February of 2018, price crossed below the EMA & acted as a bearish signal. There were instances in which price crossed above the EMA as well, which could’ve have been interpreted as a bullish signal. But as with other indicators, the EMA is also subject to fakeouts & we saw price quickly go back down. That’s why I say it’s always best to use indicators with caution and with confirmation of other indicators to help justify your decisions
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