M
oving averages are technical indicators, which actually help you to distinguish the trend direction from the false signals.
If we overlay a moving average, it will show you the clear underlying trend, instead of focusing on the random price movements.
There are different types of moving averages, which have different levels of “smoothness”.
There are two main types of moving averages:
- Simple moving averages (SMA)
- Exponential moving averages (EMA)
The simple moving average is the most commonly used type of moving averages because its method of calculation is elementary.
Simple moving averages (SMAs) are calculated by adding the prices for the period you have selected and divided the sum by the number of periods.
On the other hand, the second method – the Exponential moving averages – give more weight to the most recent periods during the calculations.
Using SMA will result in a smoother chart than using EMA.
This can eliminate most potential fakeouts.
BUT it responds slowly to the change of price and because of this lag in selling and buying signals, you might miss out on getting in on the trend early.
On the other hand, EMA is quickly moving and responding to the price changes, so you can catch the beginning of the trend.
BUT EMA tends to cause fake-outs, giving the wrong signals.
Also, longer period moving averages tend to be smoother than shorter period moving averages.
After all, moving averages are an instrument for trading, which is used to:
- Determining the market trend.
- Providing signals for purchase and sale.
- Determining the strength of the momentum of price movement (or lack thereof).
- Management of open positions such as determining loss stop levels.
- Adapt signals using various custom parameters.
- Assistance in determining the price range.
- Levels of support and resistance
If you plot different types of MAs on your chart, you will be able to see both long-term movement and short term movement.
You can overlay 6-16 or more MAs on the chart, so you could be able to define the spacing between them and what it means.
But don’t forget to “overdose” with MAs, cause it will become really difficult for you to determine which one is relevant.
First, you need to experiment with them, in order to decide which one fits your trading strategy whether you want a trend-following system or use them as dynamic support and resistance.
Then, you can use them in your real-life trading and take some really good profits.
