Four approaches to trading using moving averages

Main Summary

Moving averages are a fundamental tool for market participants, allowing them to assess the direction of price movements, identify key trend reversal points, and reduce the impact of short-term fluctuations. Based on this indicator, various trading approaches are established: the crossing of two curves, a system of multiple lines, envelopes with percentage boundaries, and MACD. While these methods provide valuable signals, their interpretation requires experience and objectivity. Professionals often combine technical analysis with moving averages with fundamental research and additional indicators to manage risks.

Introduction

Moving averages are one of the most commonly used tools in technical analysis. They allow for smoothing price data over a selected period and highlight the main trend by filtering out market noise. In practice, moving averages serve to determine entry and exit points, identify support and resistance levels, as well as assess changes in market momentum. This material discusses key trading approaches built on the use of moving averages, the mechanics of their operation, and the analytical tool they represent for the market.

What are moving averages used for in trading strategies

Moving averages serve as a filter: they eliminate market noise by smoothing out quotes, making it easier to recognize the direction of the trend. By observing the interaction of several moving averages, one can assess the current momentum and its changes. Additionally, these tools are characterized by their flexibility — their parameters can be adapted to specific market conditions and trading styles.

1. Convergence-Divergence of Moving Averages (MACD)

MACD is a composite indicator consisting of two key components: the main MACD line and the signal line (, which represents a nine-period exponential moving average ). Analyzing the interaction between these lines along with the histogram ( of the difference between them ) provides information about changes in market momentum and potential reversals.

Market participants use MACD to identify divergences between price movement and the indicator readings. A bullish divergence occurs when the price reaches new lows while the MACD shows rising lows — this is a signal of a potential upward reversal. A bearish divergence is observed in the opposite situation: the price forms new highs while the indicator shows descending highs, indicating a weakening of the upward trend.

Additionally, they analyze the intersections of the indicator lines. When the main line crosses the signal line from below, it indicates a strengthening of the upward momentum and may serve as a signal to open a buy position. A crossing from above to below indicates downward momentum and signals a selling opportunity.

2. The Intersection of Two Moving Averages

This approach is based on the simultaneous use of two moving averages with different periods. The classic variant involves a combination of 50-day and 200-day moving averages. In most cases, similar curves are used, for example, two simple moving averages — SMA(, however, the combination of different types is allowed, such as SMA and exponential moving average )EMA(.

The essence of the strategy lies in monitoring the intersection points of these lines. When the short-term curve crosses the long-term one from bottom to top ), the so-called golden cross ( forms a bullish signal indicating a potential buy. The opposite scenario — crossing from top to bottom ), the death cross ( — generates a bearish signal suggesting to sell the position.

3. Multiple Moving Average System )ribbon(

The moving average ribbon consists of a set of four to eight lines with different periods, typically 20, 50, 100, and 200 days. The intervals between them can be adjusted depending on preferences and specific trading conditions.

This system is analyzed based on the principles of expansion and contraction. When the band expands — that is, when shorter moving averages move away from longer ones against the backdrop of rising prices — it indicates a strengthening market trend and its potential duration. Conversely, the narrowing of the band ) convergence or overlapping of lines ( indicates consolidation or an approaching correction.

4. Moving Average Envelopes

This method uses a single moving average )SMA or EMA depending on the required sensitivity(, around which two envelopes are set — upper and lower — at a certain percentage distance. A typical example: 20-day SMA with boundaries at a distance of 2.5% or 5%. The percentage value is adjusted based on market volatility.

Envelopes function as indicators of overbought and oversold conditions. When the price exceeds the upper envelope, the asset may be overbought, creating a selling opportunity. A breakout below the lower envelope indicates oversold conditions and may serve as a buy signal.

) Comparison of moving average envelopes and Bollinger Bands

Bollinger Bands are outwardly similar to moving average envelopes: both systems use a central 20-day SMA and two levels above and below. However, the mechanism of their construction differs.

Envelopes are constructed using a fixed percentage deviation from the central line. Bollinger Bands, on the other hand, are positioned at a distance of two standard deviations from the central moving average, making them dynamic and dependent on volatility.

Both tools indicate overbought and oversold conditions, but in different ways. Envelopes provide signals when the boundaries are breached. Bollinger Bands provide additional insights: the contraction of the bands indicates low volatility, while expansion indicates high volatility. This allows traders to assess not only potential entry points but also the level of market instability.

Conclusion

Moving averages are a universal tool for analyzing trends, momentum dynamics, and identifying reversal points in the market. However, relying solely on these indicators is risky due to the potential for subjective interpretation of signals. Reducing risk is aided by combining various analysis methods, including fundamental research and additional technical indicators.