As a popular trend indicator, the Moving Average (MA) is used by most investors. Due to its advantage of showing a clear market picture, investors use the Moving Average to define a market.
When trying to apply a Moving Average to a chart, technical investors have multiple options. Here are the possibilities that come with the default settings in the MT4 platform:
- Simple moving average (SMA)
- Exponential moving average (EMA)
- Smoothed moving average (EMA – with a longer period applied)
- Linear weighted moving average (LWMA)
And, this is not a complete list. Other trading platforms offer variations of MA, and custom indicators can be uploaded and attached to a chart on the MT4 platform. However, regardless of the type, they all have the same purpose. The difference is that some are closer to the actual price, and some lag more, but the interpretation is the same either way.
200 MA – the Mother of All Moving Averages
A Moving Average applies its formula to a specific period. It considers the closing or opening prices of past candlesticks or periods to project a current value. As a rule of thumb, the bigger the period, the flatter the MA line will be. Also, the MA line divides the market into bullish and bearish. When the price sits above the MA, investors often look to buy dips that ideally cross the MA line. The bigger the period the MA considers, the better. On the other hand, when the market moves below the MA, investors often look to sell spikes.
The 200 MA is the most popular Moving Average used, providing the most robust support and resistance levels for future price action. The entire financial community pays attention when the price reaches the 200 MA, especially if it does so on a significant timeframe like the monthly or the weekly one.
Above is the 200 MA, more precisely, the 200 SMA (simple moving average) on the AUD/USD 4h timeframe. It is just a line that splits the chart in two, and the standard interpretation is clearly visible: bullish while above, bearish while below. The more potential the price has to reach the MA, the less likely for the resistance or support to hold.
Golden and Death Crosses
Another way of using Moving Averages is to interpret golden and death crosses. As the name suggests, the first one is bullish while the other one is bearish. For this setup, we need another MA on the chart: the 50 SMA. When the 50 SMA crosses above the 200 SMA, the entire financial community notices the bullish conditions, as a “golden cross” has just formed. Headlines appear on economic news that a certain market just entered the bullish territory. The same is valid for the currency market.
The blue line in the chart above is the 50 SMA and the golden and death crosses have been highlighted on this timeframe for AUD/USD. The 50 SMA provides support and resistance too, but not as strong as in the case of the 200 SMA.
Other strategies also exist, for example, putting more MAs on a chart and waiting for the perfect alignment. In the end, investors appreciate MAs because of the simplicity of their approach and their strong market impact on bigger timeframes.
- Multiple types of MAs exist.
- The bigger the timeframe, the stronger the support and resistance provided.
- Golden and death crosses are bullish and bearish signs, respectively.
- The more the price can test an MA, the weaker the support or resistance becomes.