Among the most widely used indicators for technical analysis and therefore trading, moving averages are somewhat complex, but also very relevant. We will therefore try to explain to you in detail and as simply as possible how these moving averages work and how they are analysed, as well as their usefulness in the context of speculation.
Moving averages are undoubtedly the technical indicators most used by investors, but require a good knowledge of how they work and how to interpret them.
A moving average actually corresponds to the average value of an asset over a defined period. It is calculated from several elements such as the opening price, the closing price, the highest and the lowest level reached for each unit of time.
The most common moving average is the one using the closing price. It then indicates the average price at which the asset has closed during the relevant time period.
The term "mobile" here indicates that this average changes with each new unit of time. This calculation is made by integrating the price of the last unit of time and subtracting the oldest price.
A distinction is also made between simple moving averages and weighted moving averages, which give more importance to certain courses.
The main types of moving averages are as follows:
These different types of moving averages differ from one another according to the importance attributed to each item over the period concerned.
Moving averages can be provided to you directly from trading platforms and are usually displayed as continuous lines on a chart. But there are two main methods of using them:
The most common method uses crosses between moving averages and prices. When prices rise above the moving average line, this is a buy signal. Conversely, when the price line crosses the moving average line on the downside, it can be interpreted as a sell signal.
Another less common but more effective method is to use crosses of two moving averages. The first of these two moving averages is of short duration and the second is of longer duration. When the short moving average rises above the long moving average, this gives a buy signal. On the contrary, when the short moving average goes below the long moving average, it gives a sell signal.
These two techniques for analysing and interpreting moving averages therefore make it possible to act in the direction of the trend and identify relevant buy and sell signals.
We note that the most used periods for the moving averages are MMS 200, 150, 50 and 20.
These periods vary above all according to the assets to which they are applied in the context of the study of moving averages. However, we advise you to test different moving average periods in order to find out for yourself which period seems best suited to your assets.
While the moving average indicator can of course be used with all kinds of strategies, there are methods that lend themselves better than others, in particular the use of take profit and stop loss orders, the operation of which we will explain here.
Let's start with how to place your take profit orders with moving averages. Here, we will wait for the price of the asset we are following to ideally reach a level of support or resistance as close as possible.
Thus, in the context of a buy position, the target here is the next level of resistance. Of course, you can also use the pivot point indicator to determine this target, or use a 'profit stop' method, which simply means exiting the position when a certain amount has been reached.
Conversely, in the context of a position taken at the time of sale, the next level of support is to be considered as the target. Here again, one can use the pivot point indicator to set this target or use a profit stop technique which also consists of exiting the market when a certain amount has been reached.
Let's now move on to the Moving Average trading strategy that uses stop losses. We will differentiate here between conservative stop losses and aggressive stop losses.
If you plan to use a conservative stop loss order as part of a buy strategy, you will ideally place your stop loss order just below the current H4 candle on the sell side, as part of a sell strategy you will place it just above the current H4 candle on the buy side.
If, on the other hand, you plan to use an aggressive stop loss strategy, you will place your stop order below the current M15 spark plug in the case of a buy position and above the current M15 spark plug in the case of a sell position.
You will of course find other ways to use the moving average indicator but placing stop loss and take profit orders is undoubtedly an interesting way to reduce risk with this technical indicator.
We will now focus on differentiating simple moving averages from exponential moving averages.
The simple moving average, also known as SMA for Simple Moving Average, is here the sum (closing price of the current period of N calculation periods) divided by N calculation periods. It is the most commonly used moving average system for traders because it is simple to calculate and easy to understand and interpret.
The exponential moving average, also called EMA for Exponantial Moving Average, is a much more complex calculation that we will not detail here because it will not be of any use to you. You should simply be aware that the formula includes here in addition a part of the current closing price which is added to the previous value of the moving average, so that the most recent closing prices are the most valuable.
It can therefore be said that the main difference between a simple moving average and an exponential moving average lies in the fact that the simple moving average does not incorporate any weighting.
It is generally considered that the use of a weighted moving average will reduce the lag by focusing more on the most recent data points.
Moving averages are among the most widely used technical and graphical indicators in the world for a variety of reasons. We invite you to discover the many advantages of this indicator here.
As you have just seen, moving averages can be used in different ways in your trading strategies. It is therefore an indicator of choice, but should not be used alone but in addition to other graphical indicators.