Moving Averages-what are they?

Moving Averages-what are they?

A moving average is a line or lines that simply smooth out price fluctuations while emphasizing the actual trend direction from fake trend directions. They also form the building blocks for many other technical indicators and overlays, such as Bollinger Bands, MACD and the McClellan Oscillator.

The term “moving average”, also mean average of prices (usually a closing price) of a currency pair for a given period. Moving average (MA) indicator helps in forecast of future prices.

The reason for using a moving average is because trends do not move in straight lines. Currency prices often zig-zag forming trending market patterns. Thus, a moving average helps smooth out the random price movements and help you “see” the underlying trend.

By looking at the slope of the moving average, one can determine the market trend direction.The “length” or the number of reporting periods including the moving average calculation affects how the moving average is displayed on a price chart.

The shorter its “length” means the fewer data points that are included in the moving average calculation, which means the closer the moving average stays to the current price (show by the red line). The tend to be close to the candles. This offers less insight into the overall trend than the current price itself.

The longer its length, the more data points that are included in the moving average calculation, which means the less any single price can affect the overall average. 

Thus, price fluctuations become “too smooth” that you won’t be able to detect any kind of trend (shown by the black line).

Because of this, it’s important to select the length (or periods) that provides the level of price detail appropriate for your trading timeframe.

You may be asking, "How can I use this to trade?”

First, we need to explain the major types of moving averages:

Exponential Moving Average (EMA)

The exponential moving average gives more weight to recent prices by illustrating a more responsive trend to new price changes. To calculate an EMA:

• The simple moving average (SMA) over a particular period is calculated first followed by the multiplier for weighting the EMA (i.e the "smoothing factor,") calculated by the formula: (2/(selected time period + 1)). 

For a 60-day moving average, the multiplier would be [2/(60+1)] = 0.03279. The smoothing factor is combined with the previous EMA to arrive at the current value. The EMA thus gives a higher weighting to recent prices, while the SMA assigns an equal weighting to all values.

Picture below shows 40 period EMA indicated by the black line,of the same period as SMA.

What Does a Moving Average Indicate?

A moving average shows the average change of data series over time. Commonly used by technical analysts to keep track of price trends for specific securities. An upward trend in a moving average usually signifies an up momentum of price, while a downward trend would be seen as a sign of price decline. They also help to confirm the suspicions that a price change might be imminent.

Simple Moving Average (SMA)

A simple moving average (SMA) is calculated by finding the arithmetic mean of a given set of prices over a specified period. A set of prices are added together and then divided by the number of prices in that set.

Picture below shows a 40 period SMA indicated by the blue line, of the same period as EMA.