Moving average: How to effectively analyze trends in trading
Antreas Themistokleous
Trading Specialist at Exness
This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.
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So, you want to start trading commodities, and believe that moving averages are tools that can help? Read on to find out how.
Since their inception in 1901, moving averages have become increasingly popular. They were first used by G. U. Yule and then W. I. King introduced them in his 1912 book, Elements of Statistical Method. Whether you’re currently using moving averages in your trading strategy or not, keep reading: you’ll learn more about how this technical tool can potentially help you with your trading.
Commodities trading is a dynamic place. Prices can swing dramatically in response to global events and economic indicators. As a trader, you are always looking for tools to navigate the complexities of the market. The moving average is a tool that has proved to be very helpful. This technical indicator, also known as MA, is a cornerstone of technical analysis. It helps traders understand price trends, volatility, and potentially when to enter and exit the market.
In this comprehensive guide, we take a close look at moving averages in commodities trading. We’ll discuss the different types, how to calculate, interpret and use them practically.
What is a moving average?
A moving average is a statistical calculation that represents the average price of a commodity over a specific period of time. It’s different from other indicators, as it doesn’t rely solely on the most recent asset’s price data. Instead, it takes into account a range of past prices while creating a constantly updated average price. This results in a smoother line that helps you identify trends and filters out the short-term moving average. The term ‘moving’ is used because the average is recalculated as new data points are added to the dataset. This results in a dynamic picture of price movement.
You can use moving averages to help you determine trend direction, making informed decisions easier. Moving averages offer valuable insights into market sentiment, whether you’re focused on short-term price movements or long-term investment strategies.
Types of moving averages
There are two common methods of calculating moving averages. Both methods serve as valuable tools for analyzing market trends and making informed trading decisions.
Simple moving average (SMA)
The simple moving average (SMA) is the most basic type of moving average. It is calculated by adding up the prices of a commodity over a specified number of periods and then dividing the total by the number of periods to get the average closing price. This easy calculation gives you a single line on the price chart, showing the average price movement over time.
To calculate the SMA use this formula:
SMA = (Sum of prices for n periods) / n
The ‘n’ represents the number of periods you might choose. The SMA provides a smooth representation of price trends, but it can be slower to respond to sudden price changes.
In the chart above we can see how the 10-day simple moving average is represented. Usually, traders combine 2 moving averages and use the crossovers to find a trade, as explained below.
Exponential moving average (EMA)
The exponential moving average (EMA) is a more advanced type of moving average that emphasizes recent price information. This makes the EMA more responsive to recent price movements. It is useful if you are trying to spot short-term trends.
The EMA calculation uses a formula that includes a smoothing factor that prioritizes recent prices:
EMA = (Current price - EMA previous day) × smoothing factor + EMA previous day
The smoothing factor depends on the number of periods you choose. A shorter period makes the EMA more responsive, while a longer period makes it smoother but potentially slower to reflect trend changes.
Interpretation of the moving averages
Moving averages have a fundamental role in identifying trends when trading commodities, generating trading signals through crossovers, and serving as dynamic support and resistance levels. Knowledge of this is crucial if you want to make informed trading decisions, and aim to catch trends while minimizing the impact of short-term price fluctuations.
Identifying trends
The primary purpose of a moving average is to identify trends in commodity prices. When the price of an asset is trading above its moving average, it suggests an uptrend. However, when the price is below the moving average, it indicates a downward trend. You can use multiple moving averages with different timeframes to confirm trends and make more confident trading decisions.
Crossovers
One of the most popular trading signals generated by a moving average is the ‘crossover.’ A crossover happens when a shorter-term moving average crosses above or below a longer-term moving average. If the short-term average goes above the long-term, it’s called a bullish crossover and you may view it as a buy signal. If it goes below, it’s a bearish crossover which is a sell signal.
For example, you could use the crossover of a 50-day SMA over a 200-day SMA as a sign to enter a trade. This strategy aims to catch trends while reducing the impact of short-term price fluctuations.
In the chart above, the blue line represents the 50-day moving average and the white line is the 200-day moving average. The crossovers provide bullish and bearish signals regardless of the trend direction of the instrument.
Support and resistance
A moving average also functions as a dynamic support and resistance level. In an uptrend, the moving average indicator can act as a support level, attracting buyers when the price dips. In a downtrend, the moving average can act as a resistance level, where sellers often appear during price increases. You’ll see this especially when the price nears the moving average, leading to potential trading opportunities.
Practical applications
You can use various moving average strategies to help guide your trading decisions. Some common strategies include:
Trend following
You can use a moving average to confirm trends and enter positions in the direction of the trend. For instance, you might buy when the price crosses above a moving average in an uptrend, to capitalize on upward momentum.
Moving average crossovers
When different moving averages cross over, they can give you signals to buy or sell. A popular combination is the crossover between a short-term exponential moving average (EMA) and a long-term simple moving average (SMA). When the EMA crosses above the SMA, it can signal a potential upward trend and vice versa.
Moving average convergence divergence (MACD)
The moving average convergence divergence (MACD) is an indicator derived from the difference between two EMAs. When the MACD line crosses above the signal line, it generates a bullish signal. When it crosses below, it generates a bearish signal. You can use the MACD to confirm trends and assess momentum.
Risk management
Moving averages can play a crucial role in risk management. They can help you spot trends and potential reversal points. You can place stop loss orders below support levels or a moving average to minimize potential losses. This approach can help you control your risk exposure while staying aligned with the current trend. Also, to assist you with your risk management strategy, you can set stop loss and take profit on your Exness account or partially close an order.
Timeframe selection
Your choice of which time period to adopt for a moving average depends on your trading style and goals. If you’re a day trader, then shorter timeframes, such as a 20-day or 50-day moving average, could potentially help you take advantage of short-term trends. These two moving averages react quickly to price changes, helping you make timely decisions. On the other hand, if you’re a swing trader or position trader, longer timeframes, like a 100-day or 200-day moving average, can give you a broader market trend outlook. These two moving averages provide a smoother representation of long-term trends, helping you spot major shifts in sentiment.
Limitations and considerations
While the moving average is a powerful tool, it is not without limitations. It's important that you be aware of these limitations so you can use the moving average effectively.
Lagging indicator
Moving averages naturally lag behind since they rely on past price data. During periods of high volatility or sudden market shifts, a moving average might not provide timely signals, potentially causing you to miss out on trading opportunities.
Whipsaw effect
In ranging or sideways markets, a moving average might give you false signals due to frequent crossovers. You must be careful when using a moving average in such conditions and consider using additional indicators for confirmation.
Single indicator risk
If you only use moving averages, your analysis might be incomplete. But if you combine the moving average with another technical indicator and basic analysis, you can get a better understanding of market conditions.
The future of moving averages in commodities trading
As technology and data analytics keep improving, you can expect moving averages to remain a fundamental tool in commodities trading. With the integration of artificial intelligence, machine learning, and big data into trading platforms, your moving average strategies will become more refined and predictive. You can expect that moving averages will keep evolving, offering new knowledge of market trends and dynamics.
However, as the trading landscape evolves, it's important that you stay grounded in the basic principles of technical analysis. While cutting-edge technologies could provide you with an advantage, the core principles of identifying trends, using crossovers, and managing risk with moving averages will remain timeless.
Navigating the markets with moving averages
In the ever-changing world of commodities trading, you can use a moving average as a reliable tool to decipher market trends, filter out noise, and make informed decisions. You can choose from a simple moving average to an exponential moving average, depending on your trading style and goals.
A moving average can offer valuable insights into price direction, support and resistance levels, and potential entry and exit points. It serves as a foundation for various trading strategies, from trend following to crossover-based approaches. If you combine it with risk management techniques and other technical and fundamental indicators, they can help you significantly improve your trading skills and navigate the complexities of commodities markets.
In an age of technological advancements, moving averages continue to be a timeless and versatile tool for traders. Whether you're a day trader capturing short-term trends or an investor analyzing long-term market dynamics, moving averages remain an integral part of a comprehensive trading toolkit.
Frequently asked questions
How does a moving average work?
A moving average (MA) line on your financial charts represents the average price of a security over a specific number of time periods, based on the closing prices of candles. You calculate it by adding together closing prices for the chosen periods and dividing by the number of those periods. The MA line helps you have a clearer view of the security's price trend, aiding in trend analysis and identifying support and resistance levels.
What are the 2 most popular types of moving averages?
The most popular types of moving averages are the simple moving average (SMA) and the exponential moving average (EMA). Your choice between EMA and SMA should be based on your trading timeframe, as the differences in their values can affect your returns significantly, especially when trading large quantities of commodities or other instruments.
Which is better, EMA or SMA?
The main difference between an exponential moving average (EMA) and simple moving average (SMA) is how they respond to data changes. An SMA calculates the average of all data evenly, while an EMA gives more weight to recent data. This means the EMA is more affected by the latest price data, while the impact of older data decreases. Ultimately, it comes down to what style of trader you choose to be, short-term or longer-term trader.
Ready to unleash the power of moving averages?
In short, moving averages are indispensable tools for trading commodities. They offer insight into price trends, support and resistance levels, and potential entry and exit points. By understanding the different types of moving averages, interpreting their signals, and implementing appropriate strategies, you can navigate the challenges of commodities markets with greater confidence and accuracy.
While moving averages have their limitations, when combined with other analytical tools, they can help you have a more well-rounded trading approach. They are crucial in technical analysis, helping you keep up with market trends and making informed decisions. With an Exness account, you can also access your favorite indicators on the move using the mobile trading terminal — sign up now and start trading commodities with the broker trusted by professional traders.
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This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.