Moving Average (MA)
Moving Average is the most popular tool in Forex. With its help, the average amount of stock value is calculated over a given time interval. Unlike the usual graph, MA gives more information about the smoothed price movement. So, if the stock price falls below the moving average, a trend can be identified as a downward trend and vice versa, if the price is higher than the MA level, the trend is growing.
A lot of traders in the financial market use special indicators that help forecast the situation correctly. One of these tools is Moving Average indicator.
How is the moving average calculated?
The moving average can be constructed in several ways.
A simple moving average is the simplest technical analysis indicator. Let's analyze the situation with an example. Let's say you set a daily SMA graph with a period of 12. The sum of the last twelve bars values divided by their number (by 12) will be calculated. As a result, you will see the average price for the last 12 bars. The reaction of the indicator to the market price change depends on the period set for its operation. The longer the period is, the slower the indicator reacts to the change in quotes.
The second type is a linearly weighted moving average. It helps assign a certain weight allowing you to focus on the later bar prices compared to the previous ones. For example, you consider 12 prices for the last 12 bars. In this case, the maximum weight (correspondingly, 12) is given to the 12th bar, and the result is divided by the sum of all the specific weights. The result will be a weighted point for this particular bar.
The exponential moving average is most often used for intraday trading. It also focuses on later prices. The exponential one is more smoothed compared to the weighted average. It's the most dynamic type and its indicator is sensitive to the latest changes that occurred in the financial market.
The smoothed moving average is the most complicated to calculate. Its feature is the lowest sensitivity, that's why most traders prefer other moving average types. This type is mainly used on graphs with the largest amplitude of the price movement.
How are moving averages used?
The Moving Average is a trend indicator, which is used in case there is a tendency for shares to increase or fall. Such a method with a lateral trend is strictly not recommended because it will lead to losses of 100 percent! The MA indicator effectively calculates the average price, but it's ineffective when the trend direction is practically unchanged. The moving averages' work is compatible with most trading strategies used in the market. In case the value is fixed above the moving average, you need to open a long position and sell the shares waiting for the moment when the price goes down. Since the indicator has a property to lag, it's important to catch the moment which is a signal for sale.
You can work with 2 moving averages at the same time. The slow line will have a longer period, and the fast one will have a correspondingly smaller period. It's necessary to open a position at the moment when the moving averages intersect. At the moment when the fast line crosses the slow one from the bottom up, you can open a long position. On the contrary, you need to sell stocks when a fast line moves from top to bottom.
Trading with the moving averages, you will necessarily think about the question, "Which time period should be in priority for the moving average?" There is no specific answer to this question. The best option is to adjust the time period individually depending on the currency you work with (shares or futures) and the time frame.
Advantages and disadvantages
The advantage of the moving averages is that they smooth out changes in the share value and help filter out the noise. According to statistics, 90% of traders reached the greatest profit working with moving averages compared with the use of other indicators.
The disadvantages of moving averages include the fact that their indicators may lag behind the current market prices. It happens because the indicator is based on data that the currency pair has shown in the past.
The Moving Average features
The MA indicator has a number of features.
- The work strategy of the indicator is most suitable for long-term trading.
- Combining the moving averages with other indicators will give an ideal result because the indicator is slow.
- Due to a large number of positive characteristics, the MA has become a basis for many other types of indicators.
Using the MA indicator in combination with other indicators, a trader can significantly reduce the risk of trading in the Forex market. Download the robot to work in the currency exchange right now and try it in action! While you've been reading this article, a lot of successful traders have already managed to earn large amounts of money using the moving averages!