The moving average or MA is one of the most common and trend following technical indicators. Having spent little time looking at price charts you must have noticed that most often price of an instrument will move up and down. In fast moving markets you may find that the price be spikes up only to drop straight down later before surging up again increasing the potential for false signals. the moving average smooths the data and help filter out the noise from random price movements and makes it easier to spot the trend.
MA are used to determine the direction of trends and to confirm reversals, To understand MA when the price is above the MA line it is consider the currency to be in an uptrend in the opposite manner if the price is below the moving average line it is considered it to be in a downtrend.
The crossover of the moving average line usually considered as trend reversals. Moving averages can also used to identify areas of support and resistance, many traders consider the moving average line as support and resistance level indicator and trades based on it.
Often the price of an instrument will find support at the moving average line when the trend is up and will find resistance at the moving average line when the trend is down. so moving average will helps to identify whether the currency is moving up down or if it’s ranging or it can tell you if a trend is still in motion and whether it is reversing or losing momentum.
Moving average is considered as trend following or lagging indicator, therefore it will not warn you in advance about the trend reversals but it will confirm when a trend change has taken place at the most basic level when the price crosses up and over the moving average. traders consider this as a signal to buy once it crosses down under the moving average line it is considered as a signal to sell.
There are two most popular type of Moving average.
- Simple Moving average (SMA)
- Exponential Moving Average(EMA)
Simple Moving Average
Let’s discuss the simple moving average or SMA first and show you how its calculated, A simple moving average is formed by calculating the average price of a currency over a specific number of periods/days. it is possible to create moving averages from the Open, High, and low value but most moving averages are created using the closing price. a 10-day simple moving average is calculated by adding the closing prices for the last 10 days and dividing the total by 10, this calculation gives equal weight to each day its called moving average as the oldest price is dropped each time a new period becomes available.
Ensuring that the average is based only on the last X number of periods in our example for the last 10 days have in mind that the longer the simple moving average period the more it lags and the slower it is to reach to the most recent price movement and this brings us to its downside as equal weight is given to all periods considered in the calculation the simple moving average is slower to respond to rapid price changes that might prove to be important so how you counter this with another type of moving average either a weighted or an exponential moving average the weighted and exponential moving averages are calculated differently from one another but both types give more weight to recent periods and thus more emphasis on what traders are doing at the moment so as a result weighted and exponential moving average responds faster to price action by distributing more weight to recent periods and less to older periods.
They reflect a quicker shift in sentiment which can be due to changes in supply and demand or important news events that impact the traded instrument to illustrate what we mean if you were to plot an exponential moving average and a simple moving average on a chart. you will see that the exponential moving average is closer to the current price than the simple moving average. apart from the type of moving average you also have to decide on the time period. this will largely depend on the type of trend you are analyzing.
Commonly used time periods 10 to 20 for short term trends
50 for midterm and 200 for long term trends.
which moving average to use and the period will depend largely on your objective.
EMA or Exponential Moving Average
Exponential moving average are also called exponentially weighted moving average and calculated by applying more weight to recent prices to reduce the lag as in simple moving averages,
The weight applied to the most recent price depends on the specific period of the moving average, shorter EMA period to add more weight on the recent price. calculating EMA is not as simple as calculating an SMA.
The important thing is that the exponential moving average puts more weight on recent prices. therefore, it reacts quicker to recent price
Use simple moving averages if you’re planning to hold a position for a longer period of time as exponential moving average might be too sensitive and give false breakout signals you should also use simple moving averages if you just like to filter out the noise and random price fluctuations to determine the overall market direction.
Exponential Moving Averages can be calculated in two ways –
1. percent-based EMA, A percent-based EMA has a percentage as its single parameter
2. period-based EMA, period-based EMA has a parameter that represents the duration of the EMA.
The formula for calculating exponential moving average is:
EMA (current) = ((Price (current) – EMA (prev)) x (Multiplier) + EMA (prev)
- Percentage-based EMA, “Multiplier” is equal to the EMA’s specific percentage.
- Period-based EMA, “Multiplier” is equal to 2 / (1 + N) where N is the specified number of periods.
The Choice of Moving average depends on your trading objective, time duration, type of trading.