Different Ways to Use a Moving Average

Trend Direction

One way to use a moving average is to look at the slope of it. While it’s not hard to see whether the price is heading higher or lower, sometimes the volatility can cause the price to swing wildly while slowly moving up or down. In this case, the moving average can give you, at a quick glance, the possible direction of a financial product without having to look at erratic price action. It can be a faster way of determining the possible trend direction.

Let’s look at an example. The image below (figure 1) shows the price of Bitcoin with a 25-period moving average overlaid on a 1-hour chart. You can see how the slope of the MA rotates between down and up. Without looking much at price, a quick look at the moving average tells us that the latest data on that image suggest that the trend is positive.

Figure 1 – BTC/USD 1-hour chart with 25-period moving average

Support or Resistance

A moving average can act as support and resistance. This is partly due to many traders looking at it as a potential reversal area and placing orders accordingly. An even better advantage is that this support or resistance is dynamic and tends to move with the price.

Let’s look at an example. Here’s a Bitcoin chart (figure 2) showing a 100-period moving average on a 4-hour chart. You can see how as price approached the moving average, the latter acted as resistance and capped any advances. We can even see some wicks which means price was attempting a break higher but failed and closed down. Eventually, prices turned lower and the trend resumed.

Figure 2 – BTC/USD 4-hour chart with 100-period moving average

Crossover

A cross of one moving average above or below another is a trading strategy in itself. A short-term moving average crossing above a long-term moving average could indicate that the trend is turning positive. The opposite is true and could indicate a bearish trend developing. 

Let’s look at an example. Here’s a daily time frame chart (figure 3) of the EUR/USD with an 8-period and a 25-period moving average. You can see how the yellow (8 period MA) crosses above and below the 25-period MA throughout the visible chart. Every time the cross happens, you can see how price trends in that direction. It’s worth noting that this is not an exact science, and not every cross will result in a move in that direction. Nonetheless, it can serve as a possible indication of a trend change, especially when looking at bigger time frames.

Figure 3 – EUR/USD daily chart with 8 and 25-period moving averages

Golden Cross and Death Cross

A golden cross occurs when a 50-period moving average crosses above a 200-period moving average. This specific cross is seen as a potential strong bullish sign. The opposite of this specific cross is a death cross and could indicate a potential bearish trend developing.

Let’s look at an example. The below image (figure 4) is a daily time frame EUR/USD chart. The yellow line is the 50-period moving average while the blue is the 200-period MA. Early on the chart, you can see how the golden cross took prices higher, from around 1.1000 to around 1.2200-2300. A death cross happened after, which saw prices moving lower from around 1.1800 to around 0.9600. A massive move that went on for more than a year. 

It’s important to note that such crosses are far from guaranteed and should only represent a possible layer of confirmation in your overall trading strategy.

Figure 4 – EUR/USD daily chart with 50 and 200 period moving averages

The Takeaway

Moving averages have their place in the trading world, but they should never be relied on fully. How you use them will depend entirely on your strategy, risk tolerance, and time frame, among other things. If you’re into trading support and resistance, a moving average can help you confirm around specific zones. If you’re a long-term trader who likes to ride trends, a crossover strategy, such as the golden cross, can help you to potentially identify trends early on.

Please be advised that any marketing commentary provided here is for educational purposes only and should not be considered financial or investment advice. Trading and investing carry a high level of risk, and investors (or potential investors) should conduct their own research and consult with a qualified financial advisor before making any decisions. Past performance is not indicative of future results, and there is no guarantee of profit. Always consider your risk tolerance, financial situation, and ability to sustain potential losses before engaging in any trading or investment activity.