The Moving Average (MA) is a fundamental indicator in technical analysis. It smooths out price fluctuations, revealing the underlying trend and potentially offering clues about future price movements.

Anatomy of the moving Average Indicator

The Moving Average (MA) is a calculated average price that smooths out price fluctuations on a chart. Imagine you have a set number of closing prices for a chosen period, like the last 50 days. To calculate a 50-day MA, you would:

• Sum the closing prices: Add up the closing prices for those 50 days.
• Divide by the number of periods: Take that sum and divide it by 50 (the number of days used in the calculation).

The result will be the average closing price for that specific 50-day period. As the chart progresses and a new day’s closing price is added, the oldest closing price drops off the calculation. This continuous recalculation based on the most recent closing prices is what gives it the name “Moving” Average. The line you see on the chart reflects this constantly updated average price.

Variations of Moving Averages

There are two main variations of Moving Averages: Simple Moving Average (SMA) and Exponential Moving Average (EMA).

• Simple Moving Average (SMA): This is the most basic MA, calculated by simply averaging the closing prices over a chosen period.
• Exponential Moving Average (EMA): The EMA assigns a higher weight to more recent prices, placing greater emphasis on the latest market activity. This results in an EMA reacting faster to price changes compared to a similarly timed SMA.

[Start of technical part – You can skip this if you just want the basic idea of EMAs]

Don’t worry about memorizing the EMA formula. The important concept is that recent prices have a bigger influence:

Here’s how the Exponential Moving Average (EMA) is calculated:

Today’s EMA = Today’s Closing Price x Multiplier + Yesterday’s EMA x (1 – Multiplier)

• Today’s Closing Price: This is the closing price for the current day.
• Multiplier: This is a factor between 0 and 1 that determines the weight given to the current closing price. It’s calculated as: 2 / (Number of periods + 1)
• Yesterday’s EMA: This is the Exponential Moving Average from the previous day.

Here’s how it works:

• Initial EMA: For the first EMA calculation (typically on day 20 for a 20-day EMA), you can’t use an EMA from yesterday. In this case, the initial EMA is often simply the SMA for that period (e.g., the 20-day SMA for a 20-day EMA).
• Weighting: The multiplier assigns a higher weight to the current closing price compared to the EMA from yesterday (1 – Multiplier). This ensures the EMA reacts faster to recent price changes than a simple moving average.

Example (20-day EMA):

Let’s say the closing price today is $50 and yesterday’s EMA was $48. To calculate today’s 20-day EMA:

Multiplier = 2 / (20 + 1) = 0.0952 (rounded)
Today’s EMA = ($50 x 0.0952) + ($48 x (1 – 0.0952)) = $48.74 (rounded)

As you can see, the current closing price ($50) has a higher influence due to the multiplier, making the EMA more reactive to recent price movements compared to a simple moving average.

[End of technical part]

The following chart shows the comparison between the Exponential Moving Average indicator (blue line) and the Simple Moving Average indicator (red line):

Interpretation

The position and slope of the Moving Average can offer insights into potential trends:

• Upward Sloping MA: This suggests an uptrend, as the average price keeps moving higher.
• Downward Sloping MA: This indicates a downtrend, as the average price keeps falling.
• Flat MA: A horizontal MA suggests a sideways market, where prices are consolidating without a clear directional bias.
• Crossovers: When a shorter MA crosses above a longer MA (bullish crossover), it can signal a potential shift from a downtrend to an uptrend. Conversely, a crossover where the shorter MA falls below the longer MA (bearish crossover) might suggest a trend reversal from uptrend to downtrend.
• Support and Resistance: A long-term MA (e.g., 200-day) can sometimes act as a level of support during a downtrend or resistance during an uptrend, as the price might find temporary buying or selling pressure at these historical average levels.

Limitations

Moving Averages are lagging indicators, meaning they react to past price movements with a lag. They don’t predict future price movements with certainty and can generate false signals, especially during volatile markets.

Why Use the Moving Average Indicator

• Price Fluctuations: Candlestick charts show individual price movements, which can be quite volatile, especially in short timeframes. This “noise” can make it difficult to see the underlying trend.
• Smoothing Effect: Moving averages help to smooth out these short-term fluctuations by averaging prices over a chosen period. This creates a smoother line on the chart that can help you better visualize the overall price direction.

Beyond What the Candlesticks Show:

• Confirmation and Early Signs: While you can identify trends directly from candlesticks, MAs can sometimes provide confirmation of a trend or even give early signs of a potential trend shift.
• Crossovers: Crossovers between shorter and longer MAs can be helpful in identifying potential trend reversals. A bullish crossover (shorter MA above longer MA) might suggest a shift from a downtrend to an uptrend, and a bearish crossover (shorter MA below longer MA) could indicate the opposite.

MAs are Not Absolute:

• False Signals: It’s important to remember that crossovers, like any technical indicator, can generate false signals. The market can be very dynamic, and trends can sometimes reverse without a clear crossover.
• Confirmation with Other Indicators: Traders often use crossovers in conjunction with other technical indicators like MACD or RSI to improve the reliability of the signal.

Overall, MAs offer a valuable tool for technical analysis that goes beyond what you can see directly on a candlestick chart.

Here’s an analogy: Imagine looking at a choppy ocean.

• Candlesticks: These are like individual waves, showing the ups and downs of the water’s surface.
• Moving Averages: These are like the average water level over time. They help you see the general direction the water is flowing (uptrend, downtrend, or sideways) despite the short-term wave movements.

So, while uptrends and downtrends are visible on the surface, MAs can be a helpful tool to see the bigger picture and identify potential trend shifts through crossovers.

How to Add a Moving Average on a Price Chart:

1. Locate the “Indicators” tab on the left-hand side of the TradingView chart interface.
2. In the search bar within the “Indicators” tab, type “Moving Average” or “MA.”
3. Select SMA or EMA: TradingView offers both SMA and EMA options. Choose “Moving Average” for SMA or “Exponential Moving Average” for EMA.
4. Configure Settings: A window will appear allowing you to configure the Moving Average.

Here, you can specify the following:

• Length: Enter the desired number of periods for the moving average (e.g., 20 for a 20-day SMA or EMA).
• Source: You can choose the data point used for the calculation (e.g., “Close” for closing price).
• Color: Select a color to easily distinguish the moving average line on the chart.

Once you’ve set your preferences, click “Apply” to add the Moving Average to the chart (or simply close the settings window).

How to Customize the Moving Average on the Price Chart

Usually charts allow you to customize the Moving Average settings by clicking on the Settings icon. This will open a small window with configuration options. In this window, you can adjust the following parameters:

• Length: This is the number of periods used to calculate the average (e.g., changing it from 20 to 50 for a 50-day SMA).
• Source: You can choose the data point used for the calculation (e.g., “Close” price, “Open” price, etc.).
• Offset: This allows you to shift the Moving Average line a certain number of periods forward or backward.
• Method: You can specify the type of MA (SMA, EMA, et.).
• Defaults Drop-Down List: This list allows you to save your current settings as a custom Moving Average or restore previously saved settings for easy reuse.

You can also set style and visibility of the indicator.

The “Length” setting in Moving Averages (MAs) affects the line’s smoothness and precision:

• Longer Length (e.g., 53): increasing the length in the Moving Average settings window results in a smoother line. This is because the average incorporates a larger number of past data points, effectively “smoothing out” the short-term fluctuations in the price. The line becomes less precise in terms of following every minor price movement.
• Shorter Length (e.g., 1): Conversely, decreasing the length leads to a line that more closely follows the price movements. With a length of 1, the Moving Average essentially becomes a single-period average, reflecting the most recent closing price. This results in a more “accurate” line in the sense that it tracks the price changes very closely, but it also becomes less smooth and more susceptible to short-term volatility.

The following chart shows the comparison between the Simple Moving Average Indicator set with length = 5 (blue line) and the Simple Moving Average Indicator set with length = 60 (red line):

Finding the Balance:

The ideal length for your Moving Average depends on your trading goals and risk tolerance:

• Short-Term Traders: If you focus on short-term trading strategies, a shorter Moving Average length (closer to the current price) might be helpful for identifying quick entry and exit points, despite the increased volatility in the line.
• Long-Term Traders: For long-term analysis, a longer Moving Average length can be useful for smoothing out price fluctuations and visualizing the overall trend. This might be less precise in terms of day-to-day movements but can provide valuable insights into longer-term price direction.

By understanding the Moving Average and its limitations, traders can gain valuable insights into potential trends and use it as a tool within their overall trading strategy.

(This information is for educational purposes only and should not be considered financial advice. Always consult with a qualified financial professional before making any investment decisions).