The Moving Averages (MA) indicator can be considered as one of the most used indicator as well as one of the oldest technical indicators in technical analysis.
Quite simply, the indicator is a mean of a progressing body of data, as seen from its name. For example, a 10-day MA is obtained by adding the closing prices for the last 10 periods being measured and then dividing the sum by 10. The term “moving” is used as only the last 10 days are used in the measurement. Hence, the calculation will result in the shifting of the data body forward with every next trading day.
The three popular types of moving averages are simple MA, exponential MA and weighted MA. It is interesting to note that you can measure moving averages on any data series comprising a forex currency’s pair opening and closing price, high, low or any other indicator. The main difference between MA variants is the weight which refers to the latest data.
Simple MA: The 10-day MA explained above is a simple MA or SMA. As mentioned earlier, it is just a calculation of the average of the currency price.
Exponential MA: There is a complicated formula required to calculate this and knowing it will not have much effect on your forex trading. The important thing you need know is that forex traders tend to prefer the exponential MA or EMA because it is faster than the SMA. EMA has less delay (lag) compared to the SMA because it places more importance on the recent prices rather than the older prices. Although, it is true that the EMA would give a faster representation than the simple moving average but faster also means more noise and higher frequency of false moves.
Weighted MA: This is type of EMA places more weight on the recent prices to make the moving average even faster. It has more noise than the SMA and EMA.
For all the three MA, the MA line will be placed directly in the price shifting chart. The MA is measured with a definite predefined period and as the period increases, the sensibility of the MA becomes less pronounced. However, if the period is shorter, the probability of false signals is higher.
Generally, you can regard the MA sa a smoothing indicator. This is because, you will find that the lows and highs of the prices are less defined and the fundamental trend of the market is more precisely seen by averaging the price. However, by its very unique characteristics, the MA line can be regarded as important in terms of market price action. A shorter period MA (eg 2-6 days) would follow the price action more closely than a 40-day MA. You will discover that everyday shifts in the price action would influence the shorter term MA more.
It is not recommended to trade only according to the MA movements and without using any other indicator. Usually, a combination of MA can help forex traders to determine the short term price movements in the context of the longer term time frame. On particular system which uses the MA effectively, in combination with MACD or RSI is the Black Dog System . The system is designed by a real forex trader, used currently on his live account, and has a 70 to 80% probability hit rate. It has a huge following and is used many live forex traders around the world. Find out how the Black Dog System had helped these forex traders around the world become profitable in their trading.