Big Idea: Moving averages are basically a collection of data points where price has been before and the average of those data points. This helps suggest the general trend of price action, and it can also be used as support or resistance. Any break in either direction could signal continued selling or buying. The different kinds of moving averages are called simple, cumulative and weighted. Traders use these various moving averages according to the type of data they would like to look at. Two main strategies traders use with moving averages is trend following and mean reversion.
Think of price action like a rubber band and the moving average is the center. If price stretches too far in either direction, the stronger the pull, and eventually, price will return to “normal” levels. Although not always 100% accurate, moving averages help the trader see what’s going on with price action and whether or not to be bullish or bearish in the short/long term.
This chart shows a 200 period simple moving average on the 15 minute timeframe. The red line moving through the middle of the chart is the moving average. You can see that price oscillates around the moving average; when price moves too high above, it eventually comes back down. When price dips under, it finds its way back up. This is a form of mean reversion, or finding a trend reversal.
Here is a different example of moving averages where we would trade the trend. This chart shows how obedient price is to the moving average and catching support at that level. Each time price tags that level, it acts as a trampoline and bounces off and continues the uptrend here.
-A moving average is a collection of data points that take the average of where price has been before
-Traders like to use moving averages for mean reversion and trend following
-Price can act like a rubber band around moving averages
-They can be used to gauge the short or long term trends of any kind of market