Trading basics: How moving averages work

Hi, it’s Brian again. Today we’re going to start talking about
indicators. Indicators help you look deeper than just
the price of a commodity or currency and help you predict when a good time to buy or sell
may be. The first indicator we’re going to take
a look at is the simplest but for many people the most effective: we’ll be exploring a
moving average. A moving average shows the average price for
a chart over a set amount of time. A moving average is used to “smooth out”
price fluctuations and help you see emerging trends in the price data. Let’s look at a fictional example. Here’s a fictional chart representing the
value of a fictional currency pair. The axis on the bottom represents hours in
the day. Let’s look at 3pm in the afternoon. A simple moving average with a period of 5
would take the average of the previous 5 hours of data. Let’s do the math. The value at 10am was 5, 11am was 7, 12pm
was 3, 1pm was 5 and 2pm was 7. The average of these values is 5.4. So, the moving average at this point in time
is 5.4. Let’s move ahead one hour to 4pm. To calculate this moving average with a period
of 5, we’ll now disregard the 10am value and add the 3pm value to the calculation. The moving average is now 6. Get the idea? There are several different kinds of moving
averages. The one in the previous example is called
a simple moving average. Another common one to see in the trading world
is an exponential moving average. It is calculated similarly, except that as
the values get older, they are weighted less in the average. The two types are used in different situations
for different things, one is not necessarily more useful than the other. Now let’s look at a real life example of
a moving average to see how they can be used. Here’s a chart for the last month of the
currency pair Monero vs. Bitcoin, XMR/BTC. Let’s add a simple moving average with an
arbitrary period of 50 to see what happens. Now do you see what I mean by the moving average
“smoothing out” the price fluctuations? When the price made it’s most impulsive
rises or drops, the moving average was relatively unchanged and showed a truer picture of the
overall trend of the currency. Another thing that you should notice is that
the moving average seems to be a good indication of when the price is going to drop or rise. It seems like the price of the currency pair
always eventually goes back to the moving average. When it’s above, it might be a little overpriced
and eventually falls. And when it’s below, it might be a little
undervalued and eventually comes around and rises. Time out: You’ll hear traders say things
like I just said all the time. They’ll act as if the price of something
responds to some indicator. Based on what we know about moving averages,
we know that’s not the case. Think back to your high school algebra class. The price of the currency or commodity is
the independent variable. Meaning it moves around independently of the
other variable, the moving average, which is the dependent variable, meaning it’s
dependent on the value of the price to calculate it’s value. This is all to say that the moving average
follows the value of the price and not the other way around. However, you’ll still hear traders talk
like it’s the other way around and the price value is some intelligent force. It’s not, that’s just how we communicate
some of these abstract concepts. You’ll know what people actually mean, just
let them talk incorrectly and move on. Now we know when the price is undervalued
or overvalued and we can identify good times to buy or sell. There are many, many other indicators out
there we’ll be talking about, but honestly, moving averages are one of the time-tested
lynchpins of most trading strategies and most traders can do quite well with them. Now that you know what moving averages are
and how you can use them, go out there and try some. I’ve got videos that should be popping up
right around these spots to show you how to use moving averages on a few different trading
platforms. Choose the one you’re using and let’s
get to work!

5 thoughts on “Trading basics: How moving averages work”

  1. Thanks for the awesome video!
    What are the best EMAs to use on Poloniex? I typically trade off of the 6hr 5min chart when things are moving fast and the 4 day 30min chart for perspective but want to get my MAs right.

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