There are two major ways to analyze the markets: technical and fundamental. Fundamental traders are using economic and political news announcement to plan their trades. Technical traders are analyzing past price performance on the chart to predict the future. For analyzing the past, traders use price patterns, simple trendlines and technical indicators.
It’s essential to note that there’s no single indicator that performs flawlessly all the time. Each market condition requires different indicator. For example, ranging markets can be traded using stochastic indicators while trending markets require moving averages. Forex trading moving average indicators are built for trading trends.
Moving average indicators overview
Moving averages are commonly used technical indicators that smooth out market noise to make trend trading easier. FX moving average indicators are also used for finding entries and exits, as well as support and resistance points. Moving averages constantly update the price and smooth out data to get a clearer visual representation of price direction on the chart.
- Moving averages are some of the simplest and most often used technical indicators
- Bollinger bands and the MACD are indicators that require the use of moving averages
- Simple and exponential moving averages are the two types of MA that are widely used by forex traders
- Moving averages are plotted over the price chart
- Moving averages can be used on any timeframe – a 14-period timeframe is especially popular among forex traders
- Understanding moving average indicators can help traders develop many trend-based trading strategies
- Moving averages are versatile indicators that are used in many trading strategies – breakout and crossover strategies being two of the most popular such strategies
Technical details of moving averages
Moving averages are used to smooth out price data from the effects of short-term fluctuations. Analyzing moving averages on their own may not yield great results, as simple and exponential moving averages are the go-to choice for traders. It’s worth mentioning that Exponential Moving Averages EMAs are more useful for traders, as EMAs give more weight to recent price movements in their calculations.
There are various Moving Average indicators Forex traders use in their analysis. To better understand how they work, we need to consider the different types of moving averages, their calculation and practical applications.
Simple moving average (SMA)
Simple moving averages are the most basic method of calculating moving averages. SMAs simply find the arithmetic mean of a set of values over a particular time period. In forex, the prices of a pair are added up over the desired number of periods and the sum is divided by the number of price points in the sample set.
The formula for calculating SMAs is as follows:
SMA = (A(1) + A(2) + … + A(n)) / N
A = average in period N
N = number of periods
SMAs are often used to smooth out the data provided by other indicators and measure the direction of a price trend.
Traders use SMAs to generate trade signals during crossovers:
- When the price crosses above the SMA, traders can go long
- When the price crosses below the SMA, traders can go short
One obvious downside of using SMA compared to EMA is that SMAs don’t give any significance to recent price developments. Market conditions frequently change, and older data typically becomes unreliable for planning future trades.
Exponential moving average (EMA)
EMAs are one of the most consumed moving average indicators fx traders apply in their analysis.
The smoothing factor is introduced in the calculation to serve as the multiplier for the EMA. The formula for the smoothing factor is:
[2 / (Selected time period + 1)]
The current EMA value is calculated by combining the smoothing factor with the previous EMA:
EMA(t) = [V(t) x (s / (1 + d))] + EMA(y) x [1 – s / (1 + d)]
EMA(t) = today’s EMA
V(t) = today’s value
EMA(y) = yesterday’s EMA
S = Smoothing factor
D = number of days
Exponential moving averages are used to generate buy and sell signals based on crossovers and divergences. On some occasions, traders use EMA lines as support and resistance lines when markets are trending. Keep in mind that moving averages are not used in ranging market conditions.
EMA vs SMA
While exponential and simple moving averages both operate similarly on a price chart and are useful in smoothing the data, they are still very different.
The key difference between the two is the use of a smoothing factor. In exponential moving averages, which places a larger emphasis on the latest price points, while the simple moving average assigns the same weight to all data points in a set. Over longer periods of time, these differences may result in considerable divergence between the two moving averages – with the EMA being more relevant to the current market conditions.
Practical application of moving averages in forex
To better understand how the simple and exponential moving averages differ from each other, we can look at moving average indicators examples.
As clearly evident by the two EUR/USD charts, exponential moving averages (lower chart) follow the price much more closely than simple moving averages (upper chart). This is why most traders favor EMAs in their strategies, while SMAs serve as reference lines for other indicators, such as Bollinger Bands.
If the EUR/USD pair starts trending up, traders can use EMA line as support for entering trades and placing stop loss orders. However, as you can see from the example, when the market is ranging, the indicator doesn’t work.
History and other useful details about moving averages
The development of Forex moving average indicators dates back to the start of the 20th century. The term was first used by R. H. Hooker, while G. U. Yule called them instantaneous averages.
The idea of exponential smoothing was introduced by R. G. Brown, who described the ideas surrounding exponential smoothing in his 1959 book on inventories.
The paper written by Charles Holt was published in 1957, which described the use of EMAs in forecasting trends.
FAQs on moving averages in forex
What do moving average indicators show?
Moving averages show the arithmetic mean of prices over a number of periods. This can show how the price has progressed over time and where it could be headed in the future. When the price of an asset crosses above the moving average, this is seen as a buy signal, and vice versa.
Are moving average indicators good for Forex?
Moving averages are some of the simplest tools available to Forex traders. The indicators provide data that can be used to determine support and resistance levels and generate buy and sell signals. However, it’s critical to know when to use them, as the indicators work in trending market conditions.
Are moving average indicators safe?
Moving averages can be effective tools in smoothing out sudden price spikes and data generated by other indicators. However, moving averages alone are not sufficient to make reliable predictions about the price of an asset, or when to go long or short. This is why MAs are used in conjunction with various other indicators and strategies.