How To Use Moving Averages

We launched HX Research about six months ago.

Over this time, we have published over one hundred and fifty pieces of original content.

We also have seen our subscriber base grow by thousands!

Recently, we have received many questions from readers about how to use moving averages.

We have a unique view of WHY and HOW they can be helpful, and today, we are sharing that view with our readers.

Here are our thoughts…

By now, you have heard us write extensively about the type of analysis called "Technical Analysis."

The definition from Investopedia of this word says…

"Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends from trading activity, such as price movement and volume."

That is a mouthful!

We will say it differently: technical analysis uses patterns in the stock price data to predict what is LIKELY to happen next.

The basic idea is to use the price history to help us predict the next move.

Now, these predictions are not about being right 100% of the time but about knowing the higher probability of moving.

The same way it would be in blackjack when you play the right hand…

In our HX Podcast, we discussed this concept with renowned technician J.C. Parets. You can listen here.

One of the most referenced technical analysis indicators is the "moving average." 

The moving average is a simple calculation. For the "50-day" moving average, you would take the last fifty days of closing prices, add them together, and divide by 50, thus getting the average.

The most used moving averages are the 50-day, 100-day, and 200-day.

Here is a chart of Bitcoin with the moving averages on the chart…

The 50-day is pink, the 100-day is green, and the 200-day is yellow.

What do these moving averages tell us?

The theory is that the moving average can act as "support" and "resistance."

"Support" is said when the asset trades down to the level of the moving average. The idea is that once it does that, it will be harder for it to continue trading lower.

"Resistance" is said when an asset trades up to the level of the moving average. The idea is that it will be harder to trade higher through the moving average.

Why would this make any sense? Isn’t it all voodoo looking at lines on a chart?

The answer is that IT DOES make sense.

The way to explain it is through a "cohort analysis." This wonky MBA term has become quite popular, but the easy way to understand it is that it is an analysis that looks at the participants in a group broken up by some measure.

We like to think of the TIME cohorts for stocks and technical analysis. This means when someone bought the stock and at what price.

This is what the moving averages tell us.

For instance, when you look at the 50-day moving average by definition, you can imagine that many people ON AVERAGE own it around that price. Again, it is the definition.

Go back to the Bitcoin chart above. The 50-day moving average is currently $54,740, and the 100-day moving average is $48,883.

This tells us that many investors are likely to own bitcoin around these levels. For the sake of this analysis, let's call it $50,000.

On average, if someone bought or sold bitcoin in the last 100 days, it was purchased around the $50,000 level.

This is why this level might act as support.

Here is why…

Suppose you bought Bitcoin for $50,000 and then sold it for $65,000. Now that it is trading back down to $50,000, you are likely to buy it again!

After all, you JUST bought it at that level and made a nice profit. Why not do it again?

We don't know how many people sold Bitcoin above $50,000, but we know many bought it around that price. Again, the average tells us that.

Here is another scenario: You bought at $50,000 and didn't sell. You think Bitcoin is going higher, or you didn't want to sell for whatever reason.

You are even less likely to sell

 once it returns to $50,000!

After all, you own it at that level and just showed a nice paper profit. Also, if you sell it below $50,000, you book a loss right after making a profit. No one wants to do that!

This is why there is some level of “support” at these moving averages.

This "support" doesn't mean the asset will not reach these levels. If the number of enthusiastic sellers willing to sell at lower prices is greater than the number of folks in the two situations we discussed above, it will go lower.

We just know that some folks have (or had) a $50,000 cost basis. At that point, they will be psychologically compelled to either buy or not sell.

Do you use moving averages in your trading? Tell us more in the comments section below…

This is the psychology of how moving averages can tell us something about the probability of what might happen next with an asset.

Understanding technical analysis cannot predict the future, but it can help you figure out how to hedge your bets…