What was your initial thought when you first heard of the term moving average (MA)?
Wait till you read this indicator's strategy name: the simple moving average crossover.
This article will help you understand what moving averages are and how you can implement them to your trading.
What is a moving average?
A moving average is one of the most common technical indicators for analyzing trends in market prices.
Since prices can be choppy, moving averages work by unwrinkling price action by averaging out a series of past price data.
Moving Average Uses:
Simple Moving Average (SMA)
There are other variations of moving averages like the EMA or the exponential moving average, and there are other indicators that are derivatives of it. The simple moving average, as its name implies, is the simplest form.
Calculating the Simple Moving Average
Now, this part is here in case you want to know the math behind the moving average and if you want to do the calculation on your own.
So, basically, and it's probably apparent to you already, that you'll be averaging records of past price data to plot the indicator on your chart.
Here's how to do it:
You may have something that looks like this.
Constructing a Simple Moving Average with Excel
To understand the process stated above, even more, you can watch the video below to see how to build a moving average using Excel.
What about the OPEN, CLOSE, and HIGH?
Remember that the purpose of an SMA is to smooth out price action, and that's why it accounts for only one price data: the CLOSE.
But some traders do make use of the highs and lows with their MAs as variants of this strategy.
It's often considered that the closing prices carry a lot more weight as it's what traders pay close attention to at the end of a trading day -- i.e., the price that buyers and sellers agreed on after concluding the day.
Trading with the Simple Moving Average crossover
Now, for the strategy part.
The most common way traders use the simple moving average is to spot a crossover of the fast MA and the slow MA.
This crossover indicates a shift to either a bullish or bearish trend.
Fast Moving Average
Typically, the fast MA can range from anywhere between 5 to 25 days (or candlesticks or bars, depending on the timeframe you're using).
It's this type of moving average that's more reactive to recent price since it averages a fewer number of price information.
Slow Moving Average
The slower MA, on the other hand, ranges from 50 to 200 days of price data.
And, in contrast to the faster MA, it isn't highly reactive to new price data since it calculates the average of more closing prices.
Moving Average Crossover
Now, as mentioned, the crossover is a signal for a possible change in trend.
When the fast MA crosses above the slower MA, that's usually a bullish indication.
But, when the faster MA crosses the slower MA downwards, then that's a bearish signal.
Here's what it looks like:
In the chart above, you'll see that the fast MA crossed under the slow MA on the 26th of July, which signaled a shift to a more bearish tone.
However, you can see that after the MAs made this signal, the prices touched the slow MA with the big green candle in August and even closed above it.
That point or level on the chart can be an opportunity to place sell orders at a much lower risk and ride the prevailing downtrend indicated by the bearish crossover signal.
The slower MA also tells the general direction of the market.
Usually, the 200-day MA is used for this.
If the price is above the slower MA, it means that the market is in an uptrend and downtrend if it's underneath.
If it intersects the prices, it indicates the market is in a sideways movement.
In some cases, these slower MAs can serve as support or resistance for traders, especially when the market is trending.
With charting applications, traders can tweak moving averages to the configuration that best suits them.
They can choose between a rounded or a more precise figure for the MA.
However, the performance or the best combination of moving averages should be backtested to understand the results on past price data.
Selecting the MA on MetaTrader 4
To find the moving averages on MetaTrader 4, follow these steps:
So, as you can see, moving averages are easy enough to set up, and it provides helpful insights like recognizing a change in trend, spotting trade setups, and other functions.
And, you can find that almost all charting packages include the MA, so it's easy enough for you to select them and apply it on the asset you're trading.
If you don't have a demo account yet, we'll show you how in this article.