A look at moving averages

Bitcoin recently bounced off its 200-week moving average. What does this mean, and why are MAs important?

Moving Averages (MAs) are standard tools used by traders in market analysis. Price moves up and down every second of every day. Moving averages take the last set of prices and average them to ‘smooth’ the signal. For example, a 50-day moving average will take the closing price on each of the last 50 days to give a broad impression of how the market is moving on a timeframe of several weeks. Plotted on a chart, they show a curving line around which spot price oscillates.

Shorter-scale MAs are useful for short-term trades, while longer MAs are useful in determining overall trend on the scale or months or even years. Earlier this month, bitcoin touched its 200-week moving average. This is the average of the weekly closing prices for the last four years. It’s a really long-term metric. Think about what is contained within that one number: price data from late 2014, when the last bear market was still under way.

The 200-week MA is a helpful tool for investors who make moves based on ‘reversion to the mean’. This is the idea that markets move up and down – sometimes a lot – but will ultimately gravitate back to their historical averages. For bitcoin, it’s not a great strategy, because BTC is so volatile and has previously staged such huge gains. The massive run-up to $20k is lost as mere ‘noise’ for the 200-week MA. However, it’s now one of those rare occasions that we’ve returned to the 200 MA. The last time BTC dropped significantly below the 200 MA was at capitulation back in January 2015 (it tracked along it for a while during the consolidation afterwards). There aren’t many ways of determining ‘fair value’ for BTC, but the long-term moving average is one way traders get gain a high-level picture of the market. In short, we believe that $3,200 is a relatively ‘safe’ price for bitcoin in the medium term. Buying opportunities below that are likely to be short-lived. (Do not take this as trading advice, as ever…)

For shorter time periods, other MAs make more sense. The 200-day and 50-day are fairly good indicators for bitcoin, since they remove a lot of noise but give a reasonable indication of the trend. The ‘Death Cross’ we saw back in April – given much publicity by mainstream analysts – did indeed herald further falls. (This is when the shorter-term MA crosses downwards over the longer-term, indicating that selling momentum appears to be building.) However, even this timescale misses a lot of medium-term movement. For day-to-day movements, the 4-hour timeframe is useful.

The fewer periods included in the MA, the more impacted it is by recent movements. (Exponential moving averages also give greater weight to more recent data.) That cuts both ways, giving a more responsive signal but ignoring earlier data that might provide useful context. Day traders might use 15-minute candles and MAs with relatively few data points, for example, because they don’t care so much about bigger weekly moves.

In short, there is no ‘right’ or ‘wrong’ MA or time period. They are a flexible indicator that gives useful data about market trend for whatever timescale you want. However, as a lagging indicator, they must be used with caution, since they reflect moves that have already happened.

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