The Moving Average, MA for short, is probably the most popular trend following indicator used by Forex traders. In this blog we will discuss more about Moving Average (MA)
What is Moving Average?
A moving average is a type of lagging indicator that accumulates past price points and then averages them to provide a technical analyst with a better sense of where a security went over a period of time. There are a handful of different moving averages, including the simple moving average (SMA) and the exponential moving average (EMA).
Moving averages help forex traders make effective transactions by aiding them in evaluating the price history of a currency pair or related investment. More specifically, these averages make it easier for investors to interpret the price fluctuations of an asset by smoothing out their random movements.
One sweet way to use moving averages is to help you determine the trend.
The simplest way is to just plot a single moving average on the chart. When price action tends to stay above the moving average, it signals that price is in a general UPTREND.
If price action tends to stay below the moving average, then it indicates that it is in a DOWNTREND.
In an uptrend, the “faster” moving average should be above the “slower” moving average and for a downtrend, vice versa.
CALCULATING THE SMA
To calculate the SMA, one must start by gathering a security’s closing prices over a fixed number of trading sessions.
If a trader wants to determine the 20-day SMA of the EUR/USD, he can add up all the currency pair’s closing prices over the time and then divide by 20. Alternatively, figuring out the 200-day SMA of the same currency pair would require totalling its closing values during that time and then dividing that sum by 200.
CALCULATING THE EMA
Calculating the EMA is a bit more complicated, as this indicator gives greater weight to more recent values in order to reduce the effect of lag. To determine this moving average, a forex trader should begin by selecting a time period, for example 10 days, and then calculating its SMA.
Next, the investor should figure out the multiplier he will use to give the most recent data points greater emphasis. The size of this multiplier will depend on how long the EMA is.
To calculate the multiplier, one can use the following formula:
Multiplier = (2/(number of time periods) + 1)
For a 10-day EMA: (2/(10 + 1)) = 0.1818 or 18.18%
For a 20-day EMA: (2/(20 + 1)) = 0.0952 or 9.52%
Once this multiplier has been acquired, the following equation can be used to determine the EMA:
If investors take the time to master the moving average and the many benefits it provides, they will have access to a wide range of tools they would not be able to harness otherwise.
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