One of the easiest technical trading patterns to learn is using moving averages. A moving average is a chart pattern drawn as a line graph of the average price over a fixed number of periods.
Day traders may look at 1 minute, 30 minute, or 60-minute intervals to calculate a moving average, but most people use the daily interval. Since we look at pricing over the last X number of periods the moving average tends to be a lagging indicator instead of a leading one.
There are also two types: the simple moving average and the exponential moving average. The SMA is the definition above, while the exponential moving average is a weighted average that gives the more recent prices more weight than prices further in the past.
The simplest trading strategy is to trade two averages against each other. For example, for short term but not day traders, two common moving averages are the 10-day and the 25-day.
Most charting software includes simple and exponential moving average data. Let’s look at the 10 and 25-day simple moving averages for Bitcoin, courtesy of Bitcoincharts.
This 3 month chart on Bitstamp shows the 10-day crossing the 25-day around July 24th indicating a buying signal. Why is this a buying signal? If the 10-day is moving higher faster than the 25-day then prices are increasing as the price of the last 10 days is also in the 25-day period. Had you gone short, this would be an indicator that you should close out the trade and go long or wait for a new shorting opportunity.
The general rule would be to keep the trade (in this case very profitable so far from around $2900 to today’s price over $4000) until the 10-day touches the 25-day again, a sign of decelerating prices or a potential entry point for a new short trade.
Many short term traders also trade the 20-day and 50-day moving averages.
Sounds easy, right? If this was all you had to do to make a profit then everyone would do it. But they don’t do it nor do all who do profit from it. There’s getting the measured periods right for your comfort and risk and managing entry and exit points.
Another common period for more intermediate traders, those who want to get a feel of sentiment over a longer term, are the 50-day and the 200-day averages. These are common in stock market trading. Let’s see how that looks on Bitcoincharts.
Every day for the last 6 months (it’s more than 12 months if you go back further) the 50-day is above the 200-day average meaning a positive sentiment for Bitcoin overall. This coincides with a period of price growth leading to tremendous profits for long traders.
As a lagging indicator, moving averages don’t always give great entry and exit points on a trade. Prices have to already be declining for the 10 day to cross the 25-day or the 50-day to cross the 200-day. This is why many use averages as a general sentiment tool and another strategy for entry and exit points on a trade. Common strategies used to find an entry point include (but not exclusively):
Many traders use more than one indicator to give them a combination of general sentiment, in this case positive, and an entry point on where to go long. The opposite is true with negative sentiment where you look for entry points to short.
Whether you use simple or exponential moving averages, these are tools you need for your trading arsenal.