Moving averages

A daily chart is full of noise: +3% today, −4% tomorrow. The simplest way to smooth the noise is a moving average – a line showing the average price over the last few days. Every day the oldest day drops out and a new one is added, hence "moving".

SMA and EMA#

• SMA (simple moving average) – adds up the closing prices of the last N days and divides by N. Every day has the same weight. SMA 50 is the average of the last 50 days.
• EMA (exponential moving average) – recent days weigh more, so it reacts faster. Faster also means more false moves.

The most common averages are 20 to 21, 50 and 200 days. There is nothing magic about those numbers – many people simply use them.

The average as a trend filter#

The most useful use is the simplest one: is the price above a long average or below it?

• Price staying above SMA 200 with the average rising – the market is more likely in an uptrend.
• Price below SMA 200 with the average falling – more likely in a downtrend.

Look at Bitcoin. At the end of 2022 the price was far below SMA 200 (the yellow line). In mid-January 2023 it rose above it and stayed there, apart from just under two months from August to mid-October.

Golden cross and death cross#

When the faster average (SMA 50) crosses the slower one (SMA 200) from below, it is called a golden cross. The opposite crossover is a death cross. The media love them because they sound dramatic.

In reality they come late. A 200-day average turns slowly, so by the time the averages finally cross, a large part of the move has already happened. On the chart above:

• The golden cross on 7 February 2023 came at a price of 23,240 – about half again above the November bottom.
• The death cross on 12 September 2023 came at 25,840, practically at the bottom. Anyone who sold on it sold before a rise to more than 40,000.
• The next golden cross on 30 October 2023 arrived at 34,475, when the price had already risen by more than a third.

The average as moving support#

In a strong trend the price often comes back to an average (for example EMA 21 or SMA 50) and bounces off it. It works like support and resistance – for the same reason: many people watch the same line. And just like support, an average can break at any time.

Common myths#

• "Golden cross = buy." It comes late, and in a range it gives one false signal after another.
• "The more averages, the better." Five lines on a chart tell you no more than one – they only confuse more.
• "There is a best setting." There is not. An average length that always works has yet to be found.