Why are moving averages so popular for traders

Moving averages are some of the most commonly used indicators by traders, in order to identify the trend direction of a particular financial instrument, although it’s considered a lagging indicator because it’s based on past prices.

What does a 50 or 200 day moving average mean?

A 50-day or 200-day moving average represents the average closing price of a security over the past 50 or 200 days, respectively. These averages help smooth out price fluctuations to identify trends.

• The 50-day moving average reflects medium-term trends and reacts more quickly to price changes.
• The 200-day moving average shows long-term trends and is slower to react.

Both are important trading signals. A "golden cross" (50-day crossing above 200-day) suggests bullish momentum, while a "death cross" (50-day crossing below 200-day) indicates bearish momentum.

Financial markets are largely volatile, with prices fluctuating wildly in short periods. This volatility can make it difficult to discern the underlying trend. Moving averages address this issue by filtering out the noise. By averaging the price over a specified period, these indicators provide a clearer picture of the market’s direction.

Identifying Trends

Traders use the MA's to confirm whether a market is trending upwards or downwards. When the price is above a moving average, it typically indicates an uptrend, while a price below the moving average suggests a downtrend. Which is particularly useful in making buy or sell decisions.

Upward momentum is confirmed by a bullish crossover, which happens when a short-term moving average crosses above a long-term moving average.

Downward momentum is confirmed by a bearish crossover, which occurs when a short-term moving average crosses below a long-term moving average, this will be clear in the example below.

In the Dow Jones (US30 Roll) chart below, you can see the blue 20-day exponential moving average along with the 50-day exponential moving average showing the trend of the market and crossing when it's time to indicate a trend change or reversal.

There are many types of moving averages but the most used are.

Simple Moving Average (SMA): This is the most basic type of moving average, calculated by averaging a set number of past data points. It gives equal weight to all data points in the period.

Exponential Moving Average (EMA): This type of moving average places more weight on recent data points, making it more responsive to new information. It smooths data in a way that prioritizes the most recent observations.

Simple moving averages (SMAs) use a straightforward arithmetic average of prices over a specified time period, whereas exponential moving averages (EMAs) give more weight to recent prices, making them more responsive to newer data points.

Support and Resistance Levels

MA's also act as dynamic support and resistance levels. During an uptrend, a stock/assets price often finds support at its moving average line. And in a downtrend, the moving average can act as a resistance level.

Traders monitor these levels closely, as they often serve as entry or exit points for trades. For instance, a price bounce off the 50-day moving average could be a buying signal, while a price drop below this average might indicate a selling opportunity.

MA’s can be applied to various time frames, from minutes to months. Short-term traders might use a 5-minute or 15-minute moving average to make quick trades, while long-term investors might prefer the 50-day or 200-day moving averages.

Easy to Combine with Other Indicators

Another reason for the popularity of moving averages is their compatibility with other technical indicators. They can be combined with tools like the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Bollinger Bands to develop more comprehensive trading strategies.