Moving averages are technical indicators that smooth out price action and helps to forecast future prices.
While using a moving average on the charts, you can predict where price will go by looking at the slope of a moving average .
Moving Average is calculated by taking the average closing prices of a currency for the last x number of periods
Moving averages follow a price’s trend therefore are lagging indicators. The longer moving average is more smooth than the shorter moving average because it averages out more prices which makes it less sensitive to new prices as they only make up a small part of the average.
Smoother/longer moving averages are slower to react to price movements compared to the short moving averages. Moving averages can be used to identify a trend, support and resistance levels and to measure price momentum.
Let’s take a look at the three types of moving averages.
- Simple/Arithmetic Moving Average(SMA)
- Exponential Moving Average(EMA)
- Weighted Moving Average (WMA)
Simple moving average(SMA)
This is just the average price of currency prices over a specific number of periods.
It is calculated by adding up the last X period’s closing prices and then dividing it by X period.
For example if you want to calculate a 10 day simple moving average of a currency price, you add up the last 10 closing prices of the currency for ten days and then divide it by 10. Keep doing the same when the next closing price is plotted while dropping the first closing price.
If you are plotting a 20 period simple moving average on an H1 chart, you would add up the closing prices for the last 20 hours and then divide it by 20 to get the moving average.
Simple moving average is itself a lagging indicator because its averaged by mostly past price data.
The longer the period you use for the SMA, the slower it reacts to the price movement.
Commonly used Simple moving averages by traders.
5 SMA for hyper traders, 10 SMA for short term traders/day traders, 20SMA also used by day traders, 50SMA mid term traders and 200SMA for long term traders.
Like any other indicator, Moving average cannot be relied on only. To avoid fake out signals it should be combined with other indicators like candlestick patterns, support and resistance and fibonacci retracement to give strong and clear signals.
Exponential Moving Average
Exponential Moving Average reduces the lag by applying more weight to recent prices. This was developed to reduce the weaknesses of the SMA indicator by weighing more recent prices heavily. The weight attached to the indicator helps it to respond more quickly to market changes.
Exponential moving average reacts more quicker to the most recent current price movements.
Formular for calculating EMA= [current price – EMA(previous) × multiplier] +EMA(previous)
Simple moving average Vs Exponential moving average
Exponential moving average shows what traders are doing recently; It relies on current happenings in the market while the Simple Moving Average relies on past events.
Exponential Moving Average responds to price action more quickly compared to SMA. This can help you identify the trend direction quickly however may not be reliable because it is likely to give fake signals due to its quick actions.
It is always important to use EMA along with other indicators for strong and clear signals.
The SMA is slow but may save you from false signals.
Weighted Moving Average(WMA)
This puts more weight on the most recent data and less weight on the older data.
The weighted Moving Average is calculated by multiplying each of the previous day’s data by weight basing on the sum of the number of days in the Moving Average.
You just have to divide the number of each day by sum of the number of days and then multiply by the value of the security then finally sum up the total weight.
Alright these calculations and formulas should not scare you. All this is done on the platform so you will not be required to do any calculations.
What is important is to know how the moving averages work and when to use them on market charts.
Let’s take a more detailed look!
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