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It's the week 2 of the season 6 steemit crypto academy. The professors have given their lectures and we are all happy to learn and participate in the homework. This homework was given by professor
@shemul21. Sit back and join me as I answer the questions
1. Explain your understanding of a moving average
Moving average is a part of the technical analysis indicator that is used to analyze the market. There are several indicators that traders use, but the moving average can be classified as one of the tools that is widely used by traders
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The moving average have a unique way of showing a trader where the price of an asset would likely move to and it can also be used to rationalize the market. The moving averages can reveal hidden patterns that we might not notice in the market as the market oscillate around the mean creating opportunities for oversold and overbought in the market. We know that the market move in three ways
- Uptrend
- Downtrend
- Consolidation
While these three directions are the ways the price of an asset moves, the moving average is capable of spotting any of those directions. With the moving averages, a trader can also know when there's going to be a reversal. The market cannot keep moving in one direction. It must reverse at a point, and the moving average can spot this point
Moving average spotting uptrend
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As earlier said, moving average can make a trader understand the market trend. When the MA line is below the price and the price is above the MA, it indicate that the market is in an uptrend, which means the bulls are taking the lead. The buyers are more active at this period. Let's see the image below
From the above image, we can see that the candles builds above the MA line and the market follows an uptrend. That is called a bullish trend, and the MA identified it
Moving average spotting downtrend
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The MA spots the downtrend the same way it does to the uptrend but in a reverse manner. As for the downtrend, when the pricemove below the MA line, a downtrend is identifiedThe line would be at the top, while the price would be below the line. Let's see the image below
Just as explained, we can see from the image how the price and the MA line position. That is a downtrend.
Consolidation
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Sometimes, the market will refuse to go neither uptrend nor downtrend. This is when we believe that both buyers and sellers are competing hard and none is ready to give up. This is when the market starts ranging. At this point, the MA line would move in between the candles which is the determinant of price. When we see this kind of movement, we can be sure that the market is consolidating
2. What Are The Different Types of Moving Average? Differentiate Between Them
There are basically three types of moving average
- Simple moving averages (SMA)
- Exponential moving averages (EMA)
- Weighted Moving Averages (WMA)
Simple Moving Averages
The simple moving averages show how the stock moves in the market, predict the future movement of assets and calculate the average movement of the market price. If the SMA is set at 20 days, it would be calculated using all the 20 days prices, and so on. If the day's price closes and another price opens, the calculation will be shifted. That's how the simple moving averages calculate the average price of an asset
The simple moving average can be realized by taking the average or the mean of the days you want to calculate. For instance, if you want to calculate the mean of 5 SMA, you would add the closing price for the 5 days and divide it by 5
Let's see one example
If the closing price for 5 days are
$5, $5.7, $10, $9.3, $8.7
The mean would be
$5 + $5.7 + $10 + $9.3 + $8.7 = $38.7
So 38.7 would be divided by the number of days which is 5
$38.7/5 = $7.74
So the average price for the 5MA = $7.74
Exponential Moving Avetages
The exponential moving average is used to spot the recent price changes by predicting the recent price actions as well as the reversal, and market fluctuation. The exponential moving averages is said to give more weight to the recent price of an asset and they can be calculated by applying today's closing price (in percentage) to the moving average of the previous day
To calculate the EMA, one would need to first get the value for the SMA, which was explained at the begining.
SO for 5 days of data, we have the SMA = 7.74
EMA= (closing price − previous day’s EMA)× smoothing constant as a decimal + previous day’s EMA
Where the smoothing constant is calculated as
2/number of periods + 1
2/5+1 = 0.33 or 33%
Remember from the SMA that the closing price is $9.3
So imputing the values into the EMA formula, we have
(9.3 - 7.74) x 0.33 + 7.74 = 8.25
Therefore, the EMA = 8.25
Weighted Moving Averages
The weighted moving average is a trend direction identifier. The recent price is weighed heavier than the previous one. From the looks of things, the weighted moving average is more accurate than the SMA because it can easily predict the trend direction, and follow the price more closely
The average given value or price is computed over a period of time and greater weight is given to the recent data
The formal is stated below
WMA = price1 x n+ price2 x (n-1) + ...... pricen/[n x (n + 1)]/2
Let's have an example where an asset trade for 5 days at
$2, $4, $6, $8, $10
We would have to assign weight to the price so we have 1, 2, 3,4,5 In ascending order
so we have
2 x 1 =2
4 x 2 = 8
6 x 3 = 18
8 x 4 =32
10 x 5 = 50
The sum of all the multiplied figures would be 110
What I did here was that I multiplied the price by the weighting factor for the 5 periods
So the sum of the 5 periods would also be calculated which goes thus
1 + 2 + 3+ 4+ 5 = 15
The sun of the multiplied figure which is 110 would be divided by the sum of the 5 periods (15)
So we have 110/15 = 7.33 as the WMA
Difference between the SMA, EMA, and , WMA
| SMA | EMA | WMA |
|---|
| Acts slower | react to short term volatility | Can combine both |
| Shows the average value or the mean over a given period | Recent data is of uttermost importance in the case of EMA | There is an emphasis on the reduction of recent data |
| It more effective with lower values | Higher values gives the EMA a better reading | The WMA combines both higher and lower value and uses it efficiently. |
| Simple calculation using a simple mean | more complex calculation | Uses both SMA and EMA in it's calculation which makes it more complex that the other two |
3. Identify Entry and Exit Points Using Moving Average. (Demonstrate with Screenshots)
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Using a moving average, the entry and exit point can be determined using the MA line and the price which is depicted by the candle sticks. When the price falls below the MA line, we can at a point take a sell position and also, when the MA line is below the price, we can at a point take a buy option. The three moving averages discussed earlier can be used to determine the entry and exit point
The moving average can be used to determine the exit and entry point on a chart. Using two charts would make the Moving averages more effective so I will use the MA of 50 periods and 500 period EMA to determine the buy and sell signal, which is the entry and exit points
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From the above image, When the 50 EMA is above the 50 MA, the price of the asset is in a bearish movement. On a contrary, when the 50 MA is above the 50 EMA, the market go bullish. We can see this from the image above
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From the above image we can see that the entry point was placed after the moving average crossed the Exponential moving average. It's a confirmation that there's going to be a bullish movement. And the stop loss is placed a little below the Moving average line
For the sell entry, we can see the image below
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Here, we can see that the price is both below the MA and EMA, but the MA seem far from the price while the EMA is closer. So we can sell there's a cross when the price is going bearish. I placed the sell after the cross, set my stop loss after the MA, and my take profit down the trend considering the support level
4.What do you understand by Crossover? Explain in Your Own Words
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The moving average can be used to determine the exit and entry point on a chart. Using two charts would make the Moving averages more effective so I will use the SMA of 50 periods and 20 period EMA to determine the buy and sell signal, which is the entry and exit points
From the above image, When the 50 EMA is above the 50 MA, the price of the asset is in a bearish movement. On a contrary, when the 50 MA is above the 50 EMA, the market go bullish. We can see this from the image above
Moving average crossing can be realized only when two moving averages are put into consideration. These two moving averages must possess a different quality in that one must be fast while the other must be slow. Only then can the cross over be realized. As for the fast moving average, it consider a few data point, which makes it react faster to the price of an asset
Conversely, the other moving average which is the slow one react slow to the price movement in the market.
Explain the Limitations of Moving Average
Every tool used for technical analysis have their shortcomings and the moving averages is not an exemption.
The moving average dwells more on past figures that are not relevant. This has a little or no effect in the market.
If care is not taken, it can give false signal especially when the indicator is not adjusted to suit the type of asset trade because of different volatility.
Moving average i s a lagging indicator that gives late signal. This can affect the price prdiction because when a signal is gotten late, the trend might have gone far.
It look over again all in the name of correcting the entire outcome any time a new data is added. So on a daily basis, the data is revised.
Conclusion
Indicators are very important tools that help traders to trade the market for profit. There are series of indicators that traders use. The moving average indicator is one of the widely used indicator. The fact that it has three types makes it more unique. The MA has the capability to separate random variations, and at the same time help to spot the support and the resistance level. The forecasting of price of an asset can also be done using the MA indicator
Also, when it comes to price smoothning, MA is very active. It can filter noise from random market fluctuations. The MA is an important tool that traders can use and if well utilized, it can help a trader to make better profit from the market
Thanks for reading
This is ckole the laughing gas
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CC: @shemul21