Moving Averages and their Purpose in Forex Trading

Moving Averages and their Purpose in Forex Trading

The Moving Average (MA) is one of the many types of technical analysis indicators. Technical Analysis is a trading methodology engaged when attempting to verify the viability of a given investment opportunity through analysing both price and volume action over a given period of time.  For effective and accurate evaluation of these trends, technical analysis employs a variety of tools otherwise known as indicators.

In terms of functionality, a moving average may be defined as a lagging indicator that utilises past prices to forecast future trends. It is expressed as a curve that simulates price bearing on the trading chart. It however has a regular motion that does not put into consideration minute price changes.

Features of The Moving Average

There is a variety of parameters that are to be considered when setting up a moving average. They include:

Timeframe  

A trader can either go long or short depending on his or her trading strategy. Long periods of time may be used so as to monitor the health and stability of a trend whereas shorter time frames majorly facilitate instantaneous profits through cashing in on short-term price advantages.

It is however important to consider the extent of accuracy as well as the number of signals when going either short or long. This is because shorter time frames are generally known to yield lesser accuracy and more signals as opposed to longer intervals which give greater precision and fewer prompts.

Traders often choose to plot two moving averages instead of one in order to balance out their accuracy and signal frequency needs. This gives them a clearer picture as far as the trend of the currency in question is concerned. A rising market is reflected when the shorter moving average is above the longer one while a falling market is shown when the longer moving average is above the shorter one.

Shift 

Moving averages either be moved forwards or backwards. This is dependent on a trader’s need to either forecast future trends or analyse past market positions. Backward shifting involves adding a comma and a negative number to the time period thus resulting in the moving average going back to the past that reflects the set past time. On the other hand, is forward shifting which is done by adding a comma and a positive number to the time frame thereby adjusting the moving average to future forecasts.

Colour

Moving average utilise colour to indicate whether the market trend is bearish or bullish as far as the currency being traded is concerned. In most cases, blue is the colour when the price is higher than the moving average while red indicates prices that are lower than the same.

Price

A Moving average is generally calculated by adding the number of currency prices over a given timeframe and then dividing the result by the total number of intervals. Opening and closing prices are thus very important when it comes to constructing moving averages over any given time span. 

The Types of Moving Averages

The following are the various kinds of moving averages:

Simple Moving Average (SMA)

The simple moving average is perhaps the most common of them all. It is calculated by simply obtaining the mathematical average of the price values over the previous time periods. This therefore means that larger periods produce smoother moving averages as opposed to shorter timeframes due to their use of more price values.

Exponential Moving Average (EMA)

The major difference between the exponential moving average and the simple one is the current nature of the data used. The EMA tends to give more relevance to the more recent data when compared to the SMA. This essentially means that the closing prices of the previous periods hold greater weight than their opening counterparts thus ensuring a smoother change between time periods.

Smoothed Moving Average  

The smoothed moving average is calculated by considering the prices within the given time periods as well as some historical information. Greater importance is given to the former even though the latter also affects the moving average obtained.

Linear Weighted Moving Average

The linear moving average is a geometric series calculation that gives precedence to the more recent price data. This essentially means that price values will only be as important as the time periods they represent. The latest price will carry a weight that represents the number of periods while the oldest price will carry only a single weight which is 1.

Conclusion

Moving Averages are a great way to identify and evaluate price trends in the forex market. Understanding them is thus vital as far as successful trading is concerned.