The moving average (MA) is one of the most simple and more powerful tools in technical analysis. It implies the calculation of a series of averages over a specific period of time that can go from one minute to four hours or 20 weeks. A line is formed by connecting each average with the next one. In charts, the MA smooths price fluctuation and helps to visualize the underlying trend. In fact, MAs are also used to identify trends.
There are two types of MA more commonly used. The simple moving average (SMA), which takes the sum of a subset of prices and divides it by the number of periods. The other one is the exponential moving average (EMA); its calculation adds more weight to the most recent prices, so it reacts faster to price changes compared to the simple MA.
MAs are lagging indicators, which implies they measure the current state of an asset, based on historical data, but they don’t anticipate future moves (leading indicators). The longer the time period for the moving average, the larger the lag. However, they still can be used to create signals. Analysts should evaluate the length and the timeframe that works better for each asset.
Moving averages often act as dynamic support and resistance levels. Technical analysts usually use two or more MAs in the same chart, and when one crosses over another, it could create a trading signal. They could also be used in combination with other indicators.
Have you ever heard of the “death cross” or the “golden cross”? They are strong market signals that confirm the change in the trend. The golden cross is when a short-term MA (usually 50-day) crosses over a long-term MA (200-day) with a nice angle and high volume, creating a bullish signal. The death cross is when the short-term MA crosses down the long-term one, suggesting the confirmation of the ongoing bearish trend.