How to Apply Moving Averages and Trend Following Indicators

You can ride the trends to profit when armed with the right tools. One of the most reliable ways to do this is by using moving averages and other trend-following indicators. If you’re trying to build a trend-following strategy in crypto trading, understanding how these indicators work – and more importantly, how to use them – is key.

Read below to get a solid grasp of how these tools work, how they can fit into your trading strategy, and why they’re particularly useful in the chaotic world of crypto.

What Is Trend Following in Crypto Trading

Before diving into moving averages and trend-following indicators, let’s first cover what trend-following really means.

In its simplest form, trend following is a trading strategy where you aim to capitalize on the price movements that persist in one direction—whether it's up (bullish) or down (bearish). In other words, you’re trying to catch the waves of a trending market.

Trend following doesn’t aim to predict the future. Instead, you react to what’s happening in the market. Once you’ve identified a trend, the strategy dictates that you continue to ride that trend until clear signs indicate it's coming to an end.

Why trend following works in crypto:

• Crypto’s volatility provides plenty of price swings and momentum, which trend-following strategies thrive on.
• Trends in crypto often last for extended periods, especially in bull or bear markets, allowing for significant profit potential if you can identify them early.

Moving Averages: The Backbone of Trend-Following Strategies

When it comes to trend-following strategies, moving averages (MAs) are the bread and butter. They smooth out price action by calculating the average price of an asset over a specified period, helping to filter out the “noise” and reveal the market’s general direction.

How to Use Moving Averages in Trend-Following Strategies

There are multiple ways to use moving averages in a trend-following strategy, but two of the most common approaches are the single moving average strategy and the moving average crossover strategy.

Single Moving Average Strategy
In this strategy, you use a single moving average to identify the trend. The rule is simple: if the price is above the moving average, the trend is considered up (bullish), and you’d look for buying opportunities. Conversely, if the price is below the moving average, the trend is down (bearish), and you’d look for selling opportunities.

Example 
Let’s say you’re looking at a 50-day EMA on Bitcoin. If the price is trading above the 50-day EMA and continues to stay there for several days, it indicates an upward trend. You might choose to go long and stay in the trade until Bitcoin’s price drops back below the 50-day EMA.

Moving Average Crossover Strategy
This approach uses two moving averages, typically a short-term and a long-term one. When the short-term moving average crosses above the long-term moving average, it's a buy signal (golden cross). When it crosses below, it's a sell signal (death cross).

Example 
You might want to use a 50-day EMA and a 200-day EMA. If the 50-day EMA crosses above the 200-day EMA, you could go long, riding the upward momentum. If the 50-day EMA crosses below the 200-day EMA, it signals a potential trend reversal, and you could exit your long position or even short the market.

Trend Following Indicators
While moving averages are a great starting point, they aren’t the only tools in the trend follower’s arsenal. Several other indicators  are designed specifically for identifying and confirming trends, like:

Average Directional Index (ADX)
The Average Directional Index (ADX) is one of the most popular trend-following indicators. It helps you determine the strength of a trend, not just the direction. This can be useful because not all price moves are strong enough to be worth trading.

The ADX ranges from 0 to 100. Readings above 25 indicate a strong trend, while readings below 20 suggest a weak or non-existent trend.

While the ADX itself doesn’t tell you the direction, it can be combined with other indicators (like moving averages) to confirm the strength of a bullish or bearish trend.

Helpful tips:

• Use ADX on higher time frames (like daily or weekly charts) to identify the major trend, and then use lower time frames (like hourly charts) for entry and exit points.
• For effective risk management, place stop-loss orders based on ADX readings. For example, in a strong trend (ADX above 25), you might place a tighter stop-loss, while in a weaker trend, you might use a wider stop-loss.

Example 
Imagine you're trading Ethereum, and your moving averages indicate a potential bullish trend. To confirm this, you check the ADX. If it’s above 25, this signals that the trend is strong, and you can confidently enter a long position. If it’s below 20, you might reconsider the trade as the trend might not have enough momentum.

Relative Strength Index (RSI)
Though primarily used as a momentum oscillator, the Relative Strength Index (RSI) can also be useful in trend following, particularly when identifying potential reversal points within a trend.

The RSI ranges from 0 to 100 and is usually interpreted as overbought when above 70 and oversold when below 30. However, in strong trends, adjusting the overbought and oversold levels (e.g., 80 and 20 instead of 70 and 30) can help avoid premature signals.

In a trend-following strategy, RSI can help you avoid entering a trade when the market is overextended or indicate when a trend might be reversing.

The RSI helps you:

1. Identify bullish swing rejection: the RSI drops below 30 (oversold), rises above 30, drops again but stays above 30, and then breaks its recent high. This can be a bullish signal.
2. Spot bearish swing rejection: the RSI rises above 70 (overbought), drops below 70, rises again but stays below 70, and then breaks its recent low. This can be a bearish signal.
3. Confirm trends: in an uptrend, the RSI tends to stay above 40 and often moves between 40 and 80. In a downtrend, it usually stays below 60 and often moves between 20 and 60.
   
    

Example

Say Bitcoin is in a strong uptrend, and you’ve been riding it for a while. But you notice the RSI is now well above 70, signaling that Bitcoin might be overbought. This could be a sign to tighten your stop-loss or even take profits before a potential reversal happens.
 

Parabolic SAR (Stop and Reverse)
The Parabolic SAR is another trend-following indicator that helps identify potential entry and exit points. It’s plotted as a series of dots above or below the price chart.

When the dots are below the price, it indicates an uptrend; when the dots are above the price, it indicates a downtrend.

A change in the position of the dots (from above to below, or vice versa) signals a potential trend reversal.

Example
Let’s say you’re holding a position in Solana, and the Parabolic SAR dots are below the price, indicating an uptrend. As long as the dots stay below, you stay in the trade. Once the dots flip to the top, you know the trend may be reversing, and it might be time to exit.
Other helpful tips:

• Stop-Loss strategy: use the Parabolic SAR dots as flexible stop-loss points. In a rising trend, set your stop-loss slightly below the Parabolic SAR dots to shield your position from unexpected pullbacks.
• Minimize false signals: the Parabolic SAR often produces misleading signals during periods of market consolidation or choppiness. Since it performs better in trending markets, pairing it with other trend-confirmation tools can help reduce these inaccurate signals.

Combine Indicators for a Robust Trend Following Strategy

One of the most powerful ways to use trend-following indicators is by combining them into a cohesive strategy. No single indicator should be used in isolation—each has its strengths and weaknesses, and combining them can give you a more comprehensive view of the market.

Example of trend following strategy

• Identify the trend: use a 50-day and 200-day EMA crossover to determine if the trend is bullish or bearish.
• Confirm the trend strength: check the ADX to see if the trend is strong enough to trade. If the ADX is above 25, it signals a strong trend. If it’s below 20, you might want to avoid the trade.
• Manage your entry and exit: use the Parabolic SAR to help pinpoint your entry and exit points. When the dots flip, it could be time to enter or exit the trade.
• Check for overbought/oversold conditions: use the RSI to avoid jumping into a trade when the market is too overheated. If the RSI is above 70, it might be worth waiting for a pullback before entering.

The Bottom Line

In crypto trading, a trend-following strategy can be a powerful approach to profit from the market’s volatility. Keep in mind that using moving averages and trend-following indicators like the ADX, RSI, and Parabolic SAR helps you identify trends, confirm their strength, and find strategic entry and exit points.

Yet, as crypto markets are unpredictable, even the strongest trends can reverse unexpectedly. But with sound risk management techniques, you’ll be able to make sense of the chaos and ride the market’s waves with more confidence.