A simple moving average is one of the most common trend-following indicators in use. Most notably, the 50-day sma and the 200-day sma, which are more or less default settings on most if not all technical software and brokerages. The 50-day sma provides an intermediate consensus of value and an average price over nearly a 3-month window. The 200-day sma similarly provides a long-term consensus of value, an average price over a 10-month period.
A moving average can tell us a few things. One, its direction can tell us the trend of the underlying asset, be it up, down, or sideways. Two, its position in relation to the asset can tell us whether the current price is below a consensus of value (price below moving average), or whether the price is above a consensus of value (price above moving average).
Lastly, but more actionable and importantly, it can be useful in providing signals. There is a lot of noise in the market, but the goal of an investor is to filter out as much as possible in an effort of hearing the signal, the alert that gets attention in a sea of clamor.
Using Bitcoin as a case study, let’s take a look at what I like to use, a weekly 8-period simple moving average to provide a signal of entry, profit-taking, or just bullish or bearish scenarios that filter my behaviors. The week of January 9th, 2023, indicated by the blue arrows on the accompanying chart, Bitcoin closed above its 8-period simple moving average for the first time since October of 2022. If we use this as a signal to enter, how would we have fared?
That week, Bitcoin closed at $20,979.70, so we will use 21k as our entry price. Using a close below the 8-period sma to close out a position as a rule, would hypothetically mean that we would still be in the trade, as BTC has tested, violated, but not closed below this 8-period sma on a weekly basis. At the time of this writing, BTC is currently trading at approximately $29,000, a 38% move since entering at our hypothetical price of 21k.
A tool is only useful when you know how to use it. An axe in the hands of a novice is not comparable to an axe in the hand of a lumberjack; the production is going to be substantially different based on skill, regardless of how crude an axe may be in tool-speak. Simple moving averages are equally robust and uncomplicated, but in the hands of an upskilled and intentional investor, results can be far beyond what the simplicity of it all implies.
We used Bitcoin as a case example, but the uses of a weekly 8-period simple moving average are the same across all asset classes. The ability to ride a trend is where the investor will see the biggest and best gains. Back-test this strategy on some of your watchlists and let me know how it goes.