Simple and Exponential Moving Averages

The simple and exponential moving average are the simplest-to-understand technical indicators and they also form the very basis of several other indicators. These indicators are also widely used by traders of all styles, but especially novice traders.

As it smoothes out price data over a specific period of time, it’s easy to identify trends and potential reversals in the market using these technical indicators.

Here’s all you need to know about simple and exponential moving averages indicators and how you can leverage their signals in your crypto trading strategy.

What Are Simple and Exponential Moving Averages?

Moving averages indicators are technical analysis tools that help identify a security’s trend direction and strength.  In the context of cryptocurrency trading, moving averages represent the price of a particular digital asset over time.

The indicators’ signals are pretty straightforward: if the price is above a moving average, the trend is up, while a price below the moving average indicates the trend is down.
There are two main types of moving averages:

1. Simple Moving Average (SMA)
   The Simple Moving Average (SMA) is used to identify trends and potential entry or exit points, providing a clear picture of the asset's overall trend. It smooths out short-term fluctuations and reveals long-term price movements.
   For example, a 30-day SMA sums up the closing prices of the last 30 days and divides them by 30 to get the average price.
   The general recommendation is to experiment with different time frames to tailor this indicator to your trading strategy.
2. Exponential Moving Average (EMA)
   The Exponential Moving Average (EMA) responds faster to current price movements compared to the SMA. 
   Cryptocurrency traders often use shorter EMAs, like 12 or 26 periods, for short-term trends and longer EMAs, like 50 or 200 periods, for long-term trends.
   

How Do the Simple and Exponential Moving Averages Work?

A moving average is calculated by taking the average price of an asset over a certain timeframe (days, weeks, or months). The moving average smooths out the fluctuations in the price data and shows the trend’s direction and strength.

Simple Moving Average (SMA): the SMA is calculated by taking the arithmetic mean of a given set of values over a chosen period.

The formula for calculating the simple moving average of security is:

SMA=nA1​+A2​+...+An​​

Where:

• An​ is the price of an asset at period n
• n is the number of total periods

Exponential Moving Average (EMA): the EMA is a bit more complex and involves three steps:

1. calculate the simple moving average for the initial EMA value
2. calculate the weighting multiplier
3. use the following formula to calculate the current EMA:
   EMA=Closing price×multiplier+EMA (previous day)×(1−multiplier)

Differences Between SMA and EMA

• The EMA gives a higher weight to recent prices, while the SMA assigns equal weight to all values.
• EMA acts faster than the SMA.  When a cryptocurrency price changes its direction, the EMA will signal this sooner than the SMA as it moves faster and focuses on recent prices. For example, if Bitcoin prices retrace lower during a rally, the EMA will go down immediately. Yet, due to its speed, the EMA could also give false signals too soon.

Reacting a bit slower than the exponential moving average, the SMA is reliable in signaling trends since it analyzes longer time frames. Due to its speed in tracking prices, EMA is considered more suitable for short-term trading, but it’s not a recommended option for triggering entries and exits on daily charts.

Interpreting Moving Averages Values

One of the most critical aspects of interpreting moving averages is noticing crossover points. These points can provide valuable insights into the market's direction. Two noteworthy crossovers are:

• Golden Cross: when a short-term moving average (e.g., 50-day) crosses above a long-term moving average (e.g., 200-day) it’s considered a bullish signal, indicating the potential for an upward trend.
• Death Cross: when the short-term moving average crosses below the long-term moving average it’s a bearish signal, suggesting a possible downtrend.

How to Use Simple and Exponential Moving Averages for Crypto Trading

Identify trends
Golden Cross and Death Cross: a "Golden Cross" shows a bullish trend while a "Death Cross" signals a potential bearish trend.

Use as support and resistance levels
When the price of a cryptocurrency is above an MA, it can act as support and when the price is below, it can act as resistance. Traders often look for price bounces off these levels to determine entry and exit points.

Spot price crossovers
Apart from the Golden Cross and Death Cross, crypto traders may also use crossovers between the price and moving averages as signals. A bullish price crossover occurs when the price crosses above a moving average, indicating an upward momentum. A bearish price crossover occurs when the price crosses below a moving average, indicating a downward momentum.

Confirm trends
Moving averages can be used to confirm a trend’s direction identified by other technical analysis tools like trendlines or candlestick patterns. If the MA aligns with the overall trend, it can provide added confidence.

Set stop loss and take profit
Moving averages can assist in setting stop-loss and take-profit levels. Traders may place stop-loss orders just below significant moving averages to limit losses, and take-profit orders just above them to secure profits.

Combining SMA & EMA with Other Technical Indicators

While moving averages are valuable on their own, their effectiveness can be amplified when used in conjunction with other technical indicators.
Some popular combinations are:

1. Moving Average Convergence Divergence (MACD)
   The MACD indicator combines two EMAs (usually 12 and 26 periods) to identify trend direction and potential reversal points. When the MACD line crosses above the signal line, it generates a bullish signal, and when it crosses below, it's a bearish signal. Combining MACD with MAs can provide more robust trend confirmation.
2. Relative Strength Index (RSI)
   The RSI measures the speed and change of price movements and is excellent for identifying overbought and oversold conditions. When used alongside MAs, it can help you filter out false signals and improve your entry and exit points.
3. Bollinger Bands
   Bollinger Bands cover a middle SMA line with upper and lower bands representing price volatility. When the price approaches the outer bands, it may indicate potential reversals. Using MAs within the Bollinger Bands strategy can enhance your ability to spot trend shifts.

Conclusion

Key takeaways about simple and exponential moving averages: 

• they’re trend-following indicators based on past prices
• they’re used not only to identify a trend’s direction but also for trade entry.

In the world of crypto trading, mastering the art of combining moving averages with other technical indicators can set you on the path to consistent profitability. 

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