How To Harness The Power of Moving Averages For Your Portfolio

Jonathan Hobbs

4 mins

How To Harness The Power of Moving Averages For Your Portfolio
  • Moving averages work out a continually updating average price of an investment over a set number of previous trading periods. The span can be hours, days, weeks, or even months.

  • Exponential moving averages are moving averages that put more weight on the recent price action, so they can be more responsive to changes in the price.

  • Regardless of which type of moving averages you use, make sure to base your analysis on “closing” prices. Also understand that moving average trading strategies work best when an investment is in a clear trend (up or down), rather than in a sideways range.

Moving averages work out a continually updating average price of an investment over a set number of previous trading periods. The span can be hours, days, weeks, or even months.

Exponential moving averages are moving averages that put more weight on the recent price action, so they can be more responsive to changes in the price.

Regardless of which type of moving averages you use, make sure to base your analysis on “closing” prices. Also understand that moving average trading strategies work best when an investment is in a clear trend (up or down), rather than in a sideways range.

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Trying to guess where the market might be headed next is no easy feat. But with moving averages, you can cut out a lot of short-term price noise and get a much clearer picture of the overall trend in an asset’s price. So let’s see why moving averages are one of the simplest – and most effective – technical indicators around.

What are moving averages?

As the name suggests, a moving average is a “moving”, or constantly updating, average of the price over a set number of recent investment periods – those can be hours, days, weeks, or even months. Here’s an example of the 200-day simple moving average, or SMA, (blue line) for the S&P 500 (black line). Notice how it’s acted as support for the price (green circles) or resistance (red circles) at different times over the past decade.

200-day simple moving average (blue line) for the S&P 500 (black line). Source: TradingView.
200-day simple moving average (blue line) for the S&P 500 (black line). Source: TradingView.

The 200-day SMA works great for US stocks. But when it comes to bitcoin, it’s all about the 20-week simple moving average (green line).

20-week simple moving average (green line) for bitcoin (black line). Source: TradingView.
20-week simple moving average (green line) for bitcoin (black line). Source: TradingView.

And for good old gold, the 100-week SMA (orange line) would’ve helped you get in and out at good times.

100-week simple moving average (orange line) for gold (black line). Source: TradingView.
100-week simple moving average (orange line) for gold (black line). Source: TradingView.

Are there other moving averages worth looking at?

There’s also the “exponential” moving average (EMA). Unlike the SMA, the EMA places more weight on more recent price action. This can give you a better sense of the latest changes in momentum.

EMAs can help you stay in your trade during the strongest parts of an uptrend, avoiding every investor’s worst nightmare of selling out too early. In the most aggressive uptrends, like bitcoin’s rallies in 2019 and in 2020-21, for example, the eight-week EMA (green line) worked well in getting most of the move up, without all the sideways chop in between. Compared to a longer-term moving average, the eight-week EMA would have nudged you out of each rally when bitcoin was at a higher price.

An eight-week exponential moving average (green line) for bitcoin (black line). Source: TradingView.
An eight-week exponential moving average (green line) for bitcoin (black line). Source: TradingView.

And the 34-week EMA seems to be the sweet spot for the Nasdaq…

34-week exponential moving average (green line) for Nasdaq-100 (black line). Source: TradingView.
34-week exponential moving average (green line) for Nasdaq-100 (black line). Source: TradingView.

What do you need to know to make these averages work for you?

Regardless of which moving averages you use (SMAs or EMAs), there are three things you need to understand to get the most out of them.

1. Always base your trading on the price “closing” above or below a moving average.

Charting tools like TradingView work out moving averages based on the “closing” price of an investment – that is, the last price it was bought or sold for in a trading session. A daily SMA or EMA of Apple (APPL) stock, for example, would be based on its stock price at 4pm Eastern time when the New York Stock Exchange closes for the day. It’s the same with weekly or monthly moving averages, only the last traded price of each week or month is used instead.

Crypto is a different story, as digital asset markets are always open for business. So for bitcoin and ether, for example, traders use the price at midnight UTC (Coordinated Universal Time) as the closing price to set daily moving averages. For weekly moving averages, they use the price at midnight UTC on Sunday.

Often, you’ll see the price quickly tick above or below a key moving average intraday or intraweek – only to then finish the trading session back where it started. While that can be an early warning sign, it’s far better to wait for the price to close above or below that key moving average before making a trading decision off the back of it.

2. Moving averages work best when an investment is in a strong trend (up or down), not when it’s trading “sideways”, or in a limited range.

When the price is in a strong uptrend for a while, and then closes below a key moving average, that’s usually a reliable signal that the trend is about to change – and it could be time to sell up and take profits. And it’s the same thing when the price is in a strong downtrend for a while and then closes above a key moving average – that could be an opportunity to buy.

But when the price is ranging sideways, it can go above and then below a moving average many times before the market makes a final decision on where it’s headed. That’s when moving average traders tend to get burned, buying and selling too frequently – often for a small loss each time.

3. If the price closes above or below one moving average, look to the next moving average as the new potential price target.

As with Fibonacci levels, an asset’s price usually breaks through each moving average in stages. You can see this with ether, below. First, the price lost the 50-day SMA (green line), then the 100-day SMA (orange line), before finally losing the 200-day SMA (red line). Also, notice how the price was above the 50-day SMA for most of the 2020-21 bull run. But once it lost the 50-day SMA for the first time in a long time, that turned out to be a major red flag for the bulls.

Ether dropping below the 50-, 100-, and 200-day moving average (green, orange, and red line). Source: TradingView.
Ether dropping below the 50-, 100-, and 200-day moving average (green, orange, and red line). Source: TradingView.

So how can you find and use moving averages?

TradingView is an easy tool to use if you’re looking to add moving averages to your strategy. To do that, you just need to follow these steps:

How to get a moving average on TradingView.
How to get a moving average on TradingView.
How to change the settings of a moving average on TradingView.
How to change the settings of a moving average on TradingView.

Now test your knowledge with our moving averages quiz.

Moving averages quiz
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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