Moving averages are the simplest and the most popular technical analysis indicators. They are used in all of the exchange trading spheres. It is one of the oldest analytical tools of the Forex market.
It's a trend indicator developed to reflect the average indications of an instrument's value. Its numerous types only differ from each other by the algorithm of these "average" indicators calculating.
In this article, we will look over the "founder" of such a direction – the simple moving average.
Simple moving average: formation principles
The constructing algorithm of such an indicator is quietly simple. Each point on its graph is calculated as the average arithmetic value of the trading instrument price for a given period of time.
This indicator is a regular analytical tool for all the trading platforms without exceptions. Most brokers offer this indicator as a base indicator and set it on the default graphs.
Configuring it, the trader needs to define the only one parameter - the period. There are no hard instructions on this matter. The choice of this parameter depends on several factors, the main of which are the following ones:
- Time frame the trade is based on;
- The way the indicator is used.
Well, the instructions are right, but common sense should prevail. For example, using the Moving Average (MA) with a period of 300 or more, on the hourly graph, doesn't make sense. Such an indicator will demonstrate a global picture so that it won't make any practical use for the short-term trading operations. For an hourly graph, the MAs with a period of 50-60 will be optimal.
On the minute graphs it is recommended to use averages with a period of 6 or 14, but as on practice, the MA use on "ultrashort" graphics doesn't make sense. The percentage of the false signals exceeds all the reasonable limits.
Ways of moving average application in trade
The range of the moving average use for the market analysis and the management decision making is enormous. It's difficult to find a technical indicator that wouldn't contain an intelligent algorithm for a simple moving average.
The primary task of such an indicator is generating signals about the presence of a trend and its direction.
In addition to this, undoubtedly global function, the correct use of the MA allows to determine the trend momentum and its potential, and even to determine the market entry points, which is unusual for the trend indicators. The MA line can also act as a support or resistance.
Let's note that it's impossible to solve these problems only on the MA basis. To determine the market potential, a trader uses three MAs of different periods. For the hourly graph, the "MA set" with periods of 50,100, 200 is the optimal one.
The Moving averages located from top to bottom in order of the period increasing, show the presence of a stable trend, and the distance between them indicates the trend momentum - the bigger the distance is, the higher is the momentum.
The "bunch" of the MAs intersecting with each other and with the AI price graph, indicate that "the market has doubt."
Speaking about transaction planning with the MA, it should be noted that it's necessary to monitor the MA and the price graph interactions. The simplest signal is the intersection - you can open a deal in the same direction as the price of the trading instrument moves. The ambiguity and the unreliability of such a signal will be considered below.
The use of the MA as the price corridor is questionable. You can set up the MA in such a way they "depict" the price corridor by selecting periods, but personally, this strongly reminds me of trying to "reinvent the wheel."
Advantages and disadvantages of the moving averages
The main benefit of the market price averaging algorithm, as well as the indicator used for the market trend analysis, is "smoothing." Those, the MA reflects the "combed" picture, which is mostly deprived of non-market extremes.
The importance of such a characteristic is high. As already mentioned, this algorithm is used in a variety of the other technical indicators on the Forex market.
The MA benefits could also be attributed to its simplicity and versatility: it can be used on any trading instrument or a time interval. The flexible setting system doesn't cause difficulties for novice traders and, at the same time, allows you to customize the indicator for the optimal use of any trading strategy.
On the other hand, as it often happens, the dignity of the indicator is a "mother" of the central defect - lagging.
Yes, the MA is a great trend indicator, but the signals come with a delay, which inevitably reduces the indicator effectiveness, and on short time frames, makes such a use pointless, or even dangerous.
A lot of the indicator modifications, including various weighted and exponential moving averages, were created precisely to increase its "efficiency." The difference between them and the classical MA means the more sophisticated algorithms of the averaged indicator are calculating. The mentioned mathematical researches brought a particular result, but despite this, most traders consider the MA signals as the weather forecasts, which are always accurate, but not always "in time."