Explaining Moving Averages in Algorithmic Cryptocurrency Trading

Wed Apr 26 2023

Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) are the most common categories of Moving Average indicators, and they widely used in manual as well as algorithmic trading. Read more.

From traditional portfolios to cryptocurrencies, TA indicators play an instrumental creating and deploying trading strategies that are more likely to lead to be successful. Today, we taking a deep dive into Moving Averages, a popular technical indicator that’s widely used in algorithmic crypto trading strategies, as well stocks and Forex.

Different Types of Moving Averages

Although there are different variations of moving averages, their underlying purpose is to drive clarity in trading charts by smoothing out the graphs to create an easily decipherable trend indicator.

Various different types of moving averages can be utilized by traders not only in day trading and swing trading but also in longer-term setups. Despite the various types, the MAs are most commonly broken down into two separate categories: simple moving averages (SMA) and exponential moving averages (EMA).

Simple Moving Averages

The SMA takes data from a set period of time and produces the average price of that asset for the data set. The difference between an SMA and a basic average of the past prices is that with SMA, as soon as a new data set is entered, the oldest data set is disregarded. All moving averages are based on a period, which determines how far back to look, and that is usually appended to the name of the indicator. For instance SMA5 takes into account the last 5 candles.

Exponential Moving Averages

EMAs are similar to SMAs in that they provide technical analysis based on past price fluctuations. However, the equation is a bit more complicated because an EMA assigns more weight and value to the most recent price inputs. This makes EMAs quicker to react to sudden change in prices compared to the EMA. Therefore EMAs generally produce more signals, which, in an algorithmic crypto trading bot will result in more trades.

How to Use Moving Averages in Algotrading

Because MAs utilize past prices instead of current prices, they have a certain period of lag. The more expansive the data set is, the larger the lag will be. This means that SMA5 is quicker to produce a buy signal compared to SMA20.

Both can be advantageous depending on the trading setup. Larger data sets benefit long-term investors because they are less likely to be greatly altered due to one or two large fluctuations. Short-term traders often favor a smaller data set that allows for more reactionary trading.

When working with MAs in your algorithmic trading strategy is important to pick the appropriate timeframe, based on how you expect your strategy to trade. Realistically, you’ll want to ensure that the signals generated by MAs are accurate, and this usually means combining other signals in your trading bot to confirm the MA signals.

MA Signal and Crossover signals

Moving averages are considered to generate a buy signal when the price of an asset is above the MA line, and the MA line has reversed its downtrend and is now pointing up.

However, A moving average alone is not a reliable and strong indicator. Therefore, MAs are constantly used in combination to spot bullish and bearish crossover signals. A crossover signal is created when two different MAs crossover in a chart. A bullish crossover (also known as a golden cross) happens when the short-term MA crosses above a long-term one, suggesting the start of an upward trend. In contrast, a bearish crossover (or death cross) happens when a short-term MA crosses below a long-term moving average, which indicates the beginning of a downtrend.

Other Factors to Consider

Different time frames can all be plugged into the equations used to calculate moving averages, and as long as those time frames are consistent with the trading strategy, the data can be useful. One major downside of MAs is their lag time. Since MAs are lagging indicators that consider previous price action, the signals are often too late.

The best way to get familiar with MA indicators is by building and observing a trading strategy based on them. Our algorithmic crypto trading platform allows you to paper trade any trading strategy for free so you can learn without risking real funds!