Understanding The Moving Average

What is the Moving Average?

The moving average, referred to as MA, is also known as the simple moving average. It is a curve formed by connecting the average currency prices within a certain trading cycle. The concept derives from Dow Jones’ average cost theory and is backed by the statistical principle of “moving average”.

The moving average can reflect the historical fluctuation of the currency price, and help traders predict future trends of the currency price. To an extent, the moving average vividly depicts how the Dow Theory and the Wave Theory operate in a graphic manner.

Use of MA

Average cost

1. According to the way it is created, the moving average reflects the average cost during a certain trading period.
2. The moving average shows the average cost of the market during a period. By comparing the candlestick charts and the moving average, traders can know the value change of relevant positions, whether the long-term, medium-term, or short-term positions.
3. If the moving average goes like the one below, it means traders are trapped in the market during the corresponding period.

Stabilize price

1. The moving average objectively records the average cost of holding positions in the market. When the currency price falls to reach the moving average, it is a bad time for traders to go short because they can get 0 profit by sale. In such a case, holders of long positions will increase their positions to prevent the currency price from falling below the cost. The lower price also provides a chance to enter for more traders, especially those who are discouraged by the high cost before. All those result in a change of force between supply and demand sides and put an end to the falling of currency prices. The moving average seems like a cushion to hold the falling currency price up to prevent it from slumping all the way.
2. Similarly, when the currency price rebounds to touch the moving average, massive sales will ensue, considering traders have been trapped in the sluggish market for a long time and are already getting impatient. Not only that, price rebounce also means profit for traders who bought in at a low market. For them, it is also a good time to sell their assets to profit. As a result, the market is oversupplied again, setting off a new round of price declines. It seems like the moving average put a cap on the price rise.
3. The figure below shows the market trend of the BTC market from the beginning of 2022 to the end of the year. As it shows, MA30\MA60\MA120 suppressed the rebound of the currency price, so a bear market formed.

1. Moving average stabilizes coin prices mainly in the following aspects:
2. Stabilize coin prices in the early stage of a buoyant or sagging market
3. Stabilize coin prices in the early stage of intensive deals
4. The function of the trend line is to stabilize coin prices
5. The function of the golden section line is to stabilize coin prices
6. The function of the Fibonacci sequence to stabilize coin prices

Moving direction prediction

1. When the currency price breaks the moving average, regardless of the direction of moving, it will always run along that direction for a while. Even if it can take a turn for a while, it will always turn back to stick in that direction at the point of touching the moving average. So one can predict the market trend from the way how the price line interacts with the moving average.
2. The trend is more obvious when the currency price breaks through the moving average and sideways market at the same time.
3. In the figure below, the price of BTC fell below MA5\MA30\MA60\MA120 in turn, falling from 20,000 US dollars to around 16,000 US dollars, with a drop of up to 20%.

The characteristics of the moving average

Delayed reaction

1. The moving average responds late to market change, especially when the market undergoes a sharp turn in a short time. So, sometimes, we might see the moving average still move in the original direction even if the market trend has changed. If one waits to act until the average trend tells, he will miss the best opportunity to profit. The longer the trading circle, the longer the moving average lags behind reality.
2. The moving average has worse performance than other trend analysis patterns, such as K-line, in quick response to market trends and giving timely trade signals. Compared with short-term moving averages, medium and long-term moving averages are even worse in this aspect.

Identify and predict trends

1. Generally speaking, the moving direction of the moving average indicates the change direction of the price, and the angle of it represents the force of the trend. When the moving average goes down, a downturn can be expected, while an up-going moving average forecasts a positive market downward. The moving averages are divided into short-term, middle-term, and long-term, with each representing how long the trend will persist.
2. The angle of the moving average represents the force of the trend. The steeper the angle, the stronger the trend represented by the line. How long the momentum will sustain is distinguished between short-term, middle-term, and long-term moving averages.

Classification of moving averages

According to the time period represented by moving average, moving average can be divided into three types: short-term, medium-term, and long-term. We can also use a combination of different types to get a more accurate prediction of the market.

Short-term

The moving average that covers a time cycle of less than 1 hour is referred to as the short-term moving average, including 30 minutes, and 15 minutes.

The short-term moving average is responsive, making it easy for traders to track price changes and make timely decisions. But traders with eyes only on short-term moving averages may become short-sighted and lose money to a hurried decision.

Middle-term

The 4H and daily moving average is a mid-term moving average.

Long-term

The moving average reflecting the weekly trend is called the long-term moving average, which is used to predict the cycle of the bullish or bearish market.

Market trend analysis

The MA follows

1. The short-term trend follow the medium-term trend, and the medium-term trend follow the long-term trend. This is the normal state of trend operation, and you should stick to holding or shorting positions in the normal state;
2. The short-term trend reverses the medium-term trend, and the medium-term trend reverses the long-term trend. This is an abnormal state of trend operation, which only appears at the turning point of the trend, that is, the bottom and the top. Choosing the entry point or exit point in the abnormal state is the principle that trend traders should follow.
3. The moving average means that when multiple moving averages converge, the moving averages of each period will have different directions, and the market outlook will follow the currency price to follow the moving average, the short-term moving average will follow the medium-term moving average, the medium-term moving average will follow the long-term moving average, the daily line will follow the weekly line, and the weekly line will follow the monthly line. The rule of thumb is: if the long-term moving average is up, the trend will continue to rise; if the long-term moving average is down, the trend will continue to go down.
4. The reversal of the moving average means that when the market trend begins to turn, it no longer follows the law of the short-term moving average obeying the medium and long-term moving average, but the currency price reverses the short-term moving average, the short-term moving average reverses the medium-term moving average, the medium-term moving average reverses the long-term moving average, and the daily moving average reverses the weekly line, the weekly line reverses the monthly line.

Trends prediction

1. Compared with the Dow theory, the moving average is a moving trend line, so there is no problem of uncertainty. The direction of the moving average is the trend direction, the cycle of the moving average is the trend cycle, and the turning of the moving average is the trend turning. Traders don’t need to compare the high and low relationship between the previous high and the previous low and the rear high and the rear low. They only need to look at the direction of the moving average to understand it clearly.
2. Like the Dow Theory, the moving average also has the disadvantage of delay in response to the market but is not as slow as the former. Of the three types of moving averages, the short-term moving average works better in a timely response, or the users can also use a combination of different types to receive timely market signals.
3. Compared with the wave theory, the time period of the moving average is roughly equivalent to the level of the trend wave operation, and the turning point of the direction of the moving average is roughly the starting and ending point of the wave. I have to say, it doesn’t get any simpler than this.

Summary

The moving average, as the most commonly used tool in market analysis, can provide a significant reference for investors to decide when to enter and exit the market. This article introduces the basics of MA and hopes to pave the foundation for more complicated contents on this topic. We hope our readers master skills of MA analysis and succeed in the market.

Please click to register on the Gate.io contract platform to start trading!

Disclaimer

This article is for informational purposes only and does not constitute any investment advice, nor is Gate.io responsible for any of your investments. Content related to technical analysis, market judgment, trading skills, and traders’ sharing cannot be used on an investment basis. Investment may involve potential risks and face uncertainties. This article does not contain or imply any guarantee for returns on any type of investment.