Crypto Trading with Moving Average - Crypto Academy |S6W2| - Homework Post for Professor @shemul21

in hive-108451 •  4 months ago  (edited)

Good day steemians, This is season 6 week 1 of the crypto academy and I'll be doing the task assigned by crypto professor @shemul21

TASKS

  1. Explain Your Understanding of Moving Average.

  2. What Are The Different Types of Moving Average? Differentiate Between Them.

  3. Identify Entry and Exit Points Using Moving Average. (Demonstrate with Screenshots)

  4. What do you understand by Crossover? Explain in Your Own Words.

  5. Explain The Limitations of Moving Average.

  6. Conclusion.



shemul.png
image designed in canva

1. Explain Your Understanding of Moving Average.

Technical analysis indicators play an important role in helping investors and traders access the financial movements of an asset price or instrument in the market and a lot of these indicators exist, each with varying uses. Of all the technical analysis indicators which exist, one notable indicator is the moving averages. The moving average is a basic technical analysis tool that helps to identify and gauge the direction of the price of an asset/instrument. It does this by creating data points with respect to its calculations over a specific period of time to smooth out data embedded in price by computing an average price that is constantly updated.

The moving averages are very important indicators and are used by both beginners and advanced level traders alike as it helps to filter the noise in the market thereby displaying potential entry points in the market more accurately. The data points that the moving average would take into consideration are dependent on the length/period setting customized by the user i.e A 50 day moving average would derive its data from the last fifty periods/price information in the market with respect to the timeframe.
An illustration of the moving average is given below:


image.png

50 day moving average added to chart
image gotten from trading view


image.png

2. Different types of moving averages

Although the basic use of the moving average is for trend identification and signal confirmation. There exist different moving averages in the financial markets and the most popular ones include

  • Simple Moving Average
  • Exponential Moving Average
  • Weighted Moving Average

Simple Moving Averagw

The Simple Moving Average is the most basic and well-known kind of moving average. Its output is calculated by computation of the arithmetic mean of a given set of values over a specified period of time. It displays the average price of an asset by making use of a dynamic line that moves in the direction of the general trend in the market by taking every new shift in price/candlestick into consideration.
The formula for the Simple Moving Average is given as follows:

SMA = (A1 + A2 +...+An) / n

In the formula above, "A" represents the mean of the specified data points over a period of time with "n" representing the number of periods/lenght set.

Exponential Moving Average

The exponential Moving Average is another form of moving average which gives more attention to recent price changes and as a result responds faster to changes in the market. Because the EMA gives more weight to recent price changes, it is more responsive than the SMA although they're both very similar in the area of tracking the direction of trends in the market.
This moving average is more ideal for short-term traders who seek to profit from volatile impulsive price movements on smaller timeframes in the market such as scalpers and a trading strategy could be formed by also combining an SMA with another EMA to discover long and short term directions.

The formula for the Exponential Moving Average is given below:

EMAc = [ Cp × (s/1+n)] + EMAp × [1 - (s/1 + n)]

In the formula above
The term EMAp is used to denote the previous day EMA
EMAc is the current day EMA
CP is the current price
S is the smoothing factor utilized
and lastly n is the specified period/length set.

Weighted Moving Average

The weighted moving average which is another moving average is a bit similar to the EMA but it puts more weight on current data points than historical points as they are accessed as more relevant and hence would have a greater impact on price. Due to its formula, the WMA tends to follow price more closely by multiplying the price of each candlestick bar in a specified period by a particular weighing factor.

The formula for the Weighted Moving Average is given below:

WMA = (Price1 × n + Price2 × (n-1) +...Pricen)/ [ n × (n+1)/2]

where n is the specified number of period.

Comparison between different moving averages

SMAWMAEMA
Indicates the general average value of a set of data over a period of timePuts more weight on the information given off by recent data and less on past dataGives an average of prioritized recent data
More suitable for identifying long-term trendsBest for scalpers who take advantage of recent price movementsMore suitable for short-term trend trading as well as early detection of reversals.
The higher the period value of the SMA, the more accurate its signalsThe WMA is reliable regardless of a higher or lower period settingA lower period setting is more reliable with the EMA.
Responds fairly to price because of the number of data points required to compute its averageMost sensitive to priceReacts faster to little price movements.


image.png

3. Identify Entry and Exit Points Using Moving Average.

The moving average has a lot of practical use which extends far beyond trend identification and confirmation as its widely used for. Being one of the most basic indicators, it's widely used by both beginner traders and advanced traders alike, and it's also made available for free on most trading and charting platforms and software.

The moving average can also be used for the determination of entry and exit signals in the market alongside trend identification. To do this, we can begin by customizing all three moving averages to chart. The 75 period simple moving average, the 75 period exponential moving average, the 75 period weighted moving average as shown below in the chart.


image.png
Moving averages added to chart
image gotten from trading view

From the above image, we can observe that the weighted moving average follows the price of the asset more closely than the other moving averages, then the exponential comes afterward, and lastly the simple moving average.

Let's develop a strategy to identify entry and exit points in the market using moving averages. For this, i'll be making use of the simple and exponential moving average. A longer period (50 period) would be used on the SMA to improve its accuracy, while a shorter period (20) period would be used on the exponential moving average to facilitate accuracy.

image.png
image gotten from trading view

A bullish market is observed in this illustration because price is seen trading above the higher period (50) SMA. The SMA would be used for general trend identification and confirmation while the EMA would be used to determine entry points in the market. We have already identified how moving averages could serve as dynamic support or resistance in a trending market.

In this situation, a strong bullish trend exists in the market and after a while price retraces down to the dynamic moving average to find support
The EMA would be used as dynamic support for this strategy and the criteria required for the determination are as follows

  • Ensure a well-defined structure exists in the market (uptrend or downtrend)
  • Confirm the trend using the higher period SMA
  • Wait for price to pull back(uptrend) or pull up(downtrend) to the lower period EMA which would be used as dynamic support/resistance.
  • wait for rejection candlestick to form and enter a buy/sell trade with effective risk management measures employed.

In the chart above, a general uptrend structure is seen and has been confirmed using the 50 period SMA. A pullback to the dynamic support (20 EMA) has been spotted and rejection candlestick formed therefore a buy trade was entered with stop loss below the EMA and take profit set above.

Entry and exit points in a bearish market

An illustration of a bearish market condition is given in the chart pair below.

image.png
image gotten from trading view

here price can be seen trading below the higher period SMA which confirms the presence of a bearish trend. After a while, price is seen retracing up to the exponential moving average, which acts as the dynamic resistance in this scenario.

From the criteria given above, a number of conditions have been satisfied. A defined structure is observed in the market, which is a bearish stricture and this trend has been confirmed with the higher period SMA.
Price has retraced up to the lower period EMA acting as dynamic resistance and rejection candelsticks were formed therefore a sell entry would be entered with effective risk management measures employed i.e stop loss level would be set above the EMA and take profit would be set below.


image.png

4. Moving Averages and Crossovers

When using moving averages, a number of strategies come into play. One of such strategy is the crossover strategy which is utilized by combining a shorter period EMA with a longer period EMA on a chart.

The shorter period EMA would tend to move more quickly and follow price closely, this is because it requires less data and statistical points to compute its average. The longer period EMA would tend to move slowly and react less to price changes over time. It can often be spotted further away from price on the chart. A larger number of historical data relative to the number of periods chosen is needed in computing the average here and therefore it reacts subtly to price but gives a more accurate measure of price.

An example is given in the chart below where two different moving averages have been added to chart.

20 period EMA line (cyan)
50 period EMA line (black)

The smaller period EMA can be spotted following price more closely than the larger period SMA. This is because of its faster response to price changes.
The larger period SMA here is more useful in displaying the overall market trend.

The crossover system has been utilized by traders to help in determining entry points with the moving average in a trending market. As a result of the fact that entries can only be given upon crossovers of the moving averages, fewer signals are generated with these trading system but with the advantage of higher probability of success.

The trade criteria for this trading strategy ara as follows:

Entry and exit criteria for a buy position

  • When the smaller period moving average exceeds the larger period moving average by crossing it from below, a buy trade should be initiated and the position should be held as long as this criteria holds.

  • The buy position should be exited when the short term moving average becomes less than the longer term moving average.
    An example of this is given below.


    image.png
    buy entry and exit using moving average crossovers
    image gotten from trading view

Entry and exit criteria for a sell position

  • For a sell position, when the smaller period moving average crosses the larger period from above, a sell trade should be initiated and the position should be held as long as this criteria holds.

  • The sell position should be exited when the short term moving average becomes more than the longer term moving average.
    An example of this is given below


    image.png
    sell entry and exit trades using moving averages crossover
    image gotten from trading view

As much as the crossover trading strategy might prove to be profitable, it however gives off choppy signals in ranging markets.This is because moving averages generally are designed to work better in a trending market. Therefore in order to guarantee optimal signals, its advised to use this strategy in trending markets.


image.png

5. Limitation of moving averages

Although the moving averages have a lot of use and advantages when trading, it's also not a perfect indicator. Some limitations of moving averages are as follows:

  • Does not respond to changes in price brought about by seasonal and cyclic changes.

  • In order to forecast, the history of different time periods have to be maintained.

  • Moving averages tend to spread out across time periods. This can be confusing and somewhat unreliable because the trend seen in a lower timeframe may be different from that of a higher timeframe.

  • Moving averages take their information from historical data and the past may be a necessary but not a sufficient metric for predicting future price movements.

  • Moving averages are not very effective in ranging markets as they tend to give off choppy signals.

Conclusion
Indicators are very important elements in the market especially when it comes to performing technical analysis on an asset. The moving average can be used to identify a brief overview of the performance of an asset over time and helps a lot in determining entry and exit signals in a trending market. However, just like most technical analysis indicators, its very advisable to combine with other indicators to get the most out of them.

The crypto professor has done an excellent job of putting forward the concept of moving averages as well as strategies to use to profit from this form of trading in a simple way. Thanks to the steemit team for the crypto academy, It's done far much in helping me tackle the markets one indicator/strategy at a time.

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