What Are Moving Averages?

Can you believe we are now on Level 6? Time flies when you’re having fun! As we enter a new level, you know what that means: another level, another technical indicator. This time, we’ll be talking exclusively about the moving average.

You wouldn’t have it any other way, right? In life, knowledge is power; in forex, knowledge is money! In this lesson, we’ll take a deep dive into one of the most popular areas of technical indicators: moving averages.

It may not sound as fancy as Fibonacci, but trust me, you’ll be chuffed to have this in your technical analysis repertoire.  First things first. Let’s talk a bit about what moving averages are, how they are derived, and how they are used to interpret price data.

What is a Moving Average?

The moving average, often referred to as “MA,” are trend indicators used to represent the average closing price of the market over a specified period of time. To do so, the moving average is calculated by proportioning a sample set of periodic closing prices. Functionally, this may be done on an equal basis per the simple moving average or via a weighted moving average structure.

One of the great things about the moving average is that it is visually discernable. On a price chart, it is displayed as a line that smoothes out price action. In this way, it can be a good indication of trend direction, pending reversal, or a potential area of support and resistance.

The moving average looks like this. It’s a line on the price chart- that’s it.

This kind of technical indicator is called a “chart overlay.” Basically, the moving average technical indicator is plotted directly on top of the price itself. As a chart overlay, the moving average can quickly and efficiently create trading signals. Why? Because the moving average is illustrated on the same chart as price!

Within the realm of technical analysis, the moving average is one of the most intuitive indicators. Pretty smart, huh? 😎

Why Do Forex Traders Value Average Price?

The main reason that moving averages are so popular is that trends don’t move in straight lines. Price zigs and zags; moving averages help smooth out the random price movements. By eliminating the “noise” of market chaos, the moving average can analyze data points and present us with an accurate view of market direction.

In fact, by just looking at the slope of the moving average, forex traders find it easier to determine the trend’s direction. This attribute is extremely valuable when attempting to make sense of recent data points.

After all, the goal of any analysis is to determine whether to buy or sell a forex pair and make money doing so. Right?

Calculating Moving Averages

Calculating a moving average indicator requires a certain amount of data, which can be a large (or not so large) quantity, depending on the length of the moving average you choose. For any moving average, there are four inputs necessary for the calculation: asset, period, data point, and type.

Asset

The first step in applying moving averages is to select a market. In forex, this means choosing one of the major, minor, exotic, or cross pairs.

Period

Selecting an appropriate period is essential to the moving average calculation. As a general rule, shorter periods are more current while longer periods are designed for macro technical analysis.

For example, a ten-day MA will require ten days of data, while a one-year MA will require 365 days’ worth. 

Data Point

It’s necessary to select a periodic data point by which to calculate the moving average. This may be a closing price, opening price, median or mid of periodic price data. 

Type

Moving averages may be calculated in a multitude of ways before being plotted on the price chart. A few of the most common are the simple moving average (SMA), exponential moving average (EMA), and smoothed moving average (SMMA).

Moving Average Basics

So, what does all this mean? Let’s put it together. Assume that you are a EUR/USD intraday trader that is interested in a basic view of short-term price action.

In this instance, a good moving average to use would be a 20-period SMA based on the closing prices of a 5-minute EUR/USD price chart. While there are many ways to go, 20 periods, closing prices, and the 5-minute chart are all feasible for an intraday technical indicator.

Let’s sum up the basic tenets of moving averages:

• Moving averages can be used in multiple time frames. This may encompass minutes, hours, days, weeks, months, and years.
• The shorter the period, the fewer data points are included in the moving average calculation. This means that the moving average will stay closer to the current price.
• The longer its length, the more data points are included in the moving average calculation. This means that a single data point has a reduced impact on the overall average.
• There are many types of moving averages. Among the most common are the simple moving average, the exponential moving average, and the smoothed moving average.

But that’s enough mumbo jumbo, let’s talk about how YOU can use these powerful technical indicators to make money in the forex.

Want to Learn About the Simple Moving Average and Exponential Moving Average?

Before we’re done with moving averages, we’ll discuss two major types: the simple moving average (SMA) and the exponential moving average (EMA). We’ll also teach you how to calculate them and give the pros and cons of each. Once you know how simple moving averages and exponential moving averages work, you’ll be ready to integrate them into your trading.

Each level in the HowToTrade Free courses is designed to improve your chances of becoming a profitable trader. Once you’re pumped and ready to go, head to the next lesson!

Mimic how professionals trade. Discover your inner talent.

Learn everything you need to know about trading the markets from beginner level to the most advanced, helping you to create critical skills and techniques to you can apply in your trading right away.

Join Free Now