How to trade - Moving Averages

Introduction

Ever since I joined this space in 2020, I've been fond of trading and have tried various different trading systems over the years. From trying to use hundred different indicators to just relying on basically a few of these, I've come a long way and I'm sure most if not all those who've spent years in this would relate.

In this short blog (thanks to GREED Academy), I'll be going over one of my longer term strategies utilising one of the simplest indicators which is potentially one of the most overlooked indicators when it comes to trading - the Moving Averages. So, without further ado, let's get started!

What are MAs?

Well on the forefront, it looks very simple - Moving averages are.. well, just averages of N number of candles. That's it. However, let's take a moment to understand a bit about how they work and what they are. To dive into them, let's first understand the different parts of a candlestick chart.

This is the basic anatomy of a candlestick chart. We got Green and Red candles depending upon if the price at which the candle closed is greater or lesser than the opening price of that candle respectively. Now, that the 4 different points of a candle are clear i.e the Open, High, Low and Close or OHLC for short, we shall take a look at what these MAs are all about.

So as stated earlier, Moving Averages are averages of N number of candles where N can be defined by the user. However, you would have asked the question what are we exactly averaging in this case? Well, that's also kind of upto you. MAs on popular charting platforms like TradingView allow you to change what the input of a particular candle would be i.e should you be averaging the Open of the candle or its close or highs or lows etc.The most famous point that is by default averaged out is the OHLC/4 point or sum of Open, High, Low and Close divided by 4. This is meant to sort of give the average price of a candle while also considering its price fluctuation and thus smoothing the average out.

Now, what Moving Averages or MAs do is basically take each of this input point upto N candles and averages them out. Since each day you'll get new average, it plots this into a line thus giving you the Moving Average. While this is all well and good, there are also Exponential Moving Averages or EMAs for short that are a weighted average of the input points rather than a basic average.

Now that we've understood what makes these MAs and EMAs i.e the period or the number of candles you'd like to lookback to and the input price point of each candle, let's understand how to utilize them.

How to use them?

Think of 2 MAs, one being a 20 MA i.e the lookback period or the number of candles it will be averaging out is 20 and another which is a 100 MA i.e taking input of the past 100 candles. If you understand the basic concept of MAs, you might think that the 20 MA would be more susceptible to current price action than the 100 MA and thus would be a short term trend following MA while 100 MA would be a relatively longer term trend following MA.

AND THAT'S RIGHT!

From the image above, you can get a feel of how a 100 MA is smoother than its 20 MA counterpart. Typically, these averages tend to be a good point to buy/sell during trending enviroments i.e those periods when price keeps going up or down for majority of the time.

Also, do note that if we're in a up trending environment which is where these MAs tend to shine, you'll always see these MAs in order of their periods i.e 20 MA would be higher than 50 MA which would be higher than 100 MA and so forth. The reverse would be true if it was a downtrend environment.

Can you think of why that might be the case? Hint: Short term vs long term MAs

Now, the strategy that I'll be discussing below, typically used by one of the crypto twitter goats - Pierre utilizes a combination of short to mid to long term period MAs along with some additional confluence to enter trades.

How to use it - A simple analysis

While I use it predominantly with market structure, there isn't any hard rule on using it. You can use it with additional confluence from other indicators or use it along with fundamentals, the list is endless. Let's see a basic way of using it with another indicator called Relative Strength Index or RSI.

Without diving into the RSI much, a good thumb rule for using it is if it's outside the bands (i.e the purple shaded region) , it's a good time to buy or sell depending if it's below the region or above it respectively.

Now, get the MAs on your chart. Typically it would be ideal if you use 1 short term, 1 mid term and 1 long term MA such as the popular combination of 30,100 and 200 MA which is what I'll also be using in this case. In our example below, we see that the price was in a downtrend which is visible by the fact that 30 MA (Yellow) is lower than 100 MA (Orange) which is lower than 200 MA (Red). Typically between switching from a downtrend to an uptrend you would see periods of low volatility where these MAs just coil up together which is what you see next followed by an up trend move.

Now, when price touches the middle 100 MA (Orange line) prior to the anomaly part, you can see two things:

• Firstly, price had a change in trend as can be seen by the MAs
• Secondly, if you do know the basics of Price market structure, you'll notice that it is still in a bullish market structure
• RSI was hugging the lower band of the purple region and did go lower during this time

These 3 indicators give you the confluence together than buying here is a good idea . Your stop loss in this case would be a break of market structure (which is the lowest price point in that coiled up region). As you can see, price did rally a good % after that validating your idea.

While I've only given one exmaple to keep this blog short, you can find numerous examples across BTC, ETH, SOL and potentially other altcoins (though I don't trade them that much).

What's next?

So, this was a basic attempt at explaining MAs to a newbie and hence why this just scratches the surface of MAs. You can now go ahead and delve a bit deeper into MAs, try to FAFO and have fun curating your own strategy around it.

If you want to learn some more about it, Tunez has some amazing stuff on MAs via which you can get started with.

I hope you enjoyed this sort of disjointed piece on MAs!

Midwit out!