The moving averages represent an index of the sort that helps investors identify trends based on which they make investment decisions, its considered to be a tool worth mastering as moving average experts are able to extract profits or minimize loss during a recessionary or contraction phase. When applied to forex trading moving averages provide remarkable insights into what kind of strategy should be adopted.
Moving averages are relative to a time period. Two types of moving averages the simple moving average which refers to average over a given number of time periods coupled with the exponential moving average which reflects the most recent time periods more significantly are used to shape forex strategies. These two are referred to as Technical Indicators and also denote support and resistance levels for any forex stock. The 50, 100 and 200 day MA’s are considered to be adequate reflections of support and resistance levels. They help traders so remarkably that all the best forex trading software now incorporate them in their system.
Moving average is defined as a technical analysis tool that keeps the price data smooth by calculating an updated value for price/cost. As mentioned above the average is taken over a fixed time period which could be 50,100 or 200 days/units of time. Moving average strategies are effective as well as prominent as they not only suit long-term strategy but can also be applied very effectively to short-term decisions. This tool for analysis is available on good forex trading software, that are used because a trader can read the ongoing trends and make a decision based on it.
The simple moving average is like the arithmetic mean which is calculated by keeping the closing price of the forex stock and dividing it by the total number of periods that are being considered. A simple moving average is used as it takes out the volatility i-e the outliers of any specific forex asset and shows a smooth value using which investment strategy for forex can be determined. It also makes the price trend clear. If the simple moving average is going up it means the price of the asset is increasing and vice versa. The timeframe considered is also important as shorter time frames have more widely fluctuating ranges while longer time frames tend to return a smoother SMA. The uptrend or downtrend of any asset can easily be seen through the simple moving average.
The advantages of using SMA are that it removes any outliers and can clearly indicate whether the market has entered support or resistance phase, this, in turn, can easily determine whether the investor should plug more or pull out. The simple average keeps the price line smooth, so it does not take into account any volatile recent price movements.
The exponential moving average (EMA) is known as a weighted average which gives a higher weight-age to current or recent prices as compared to the older ones. The EMA is more volatile if the price changes have been happening more in the recent time periods. There is a value called the multiplier which is used along with the SMA to calculate the EMA.
Calculating the EMA requires that we know the SMA, calculate the value of the multiplier and then use both the values to come up with the value of the EMA.
The advantages of using EMA are obvious, the weighted average which is chained to the most recent fluctuations in price takes into account the volatility of the recent trends so the investors are in a better position to make an informed decision.
The terms support and resistance have a slightly different meaning when it comes to MA’s. Support refers to a situation in which the average acts like a floor so the average bounces above it. That happens during an uptrend. In a downtrend, however, the average acts like a ceiling I-e the highest point so the average drops once it touches that point.
The standard lengths for moving averages are 10 20 50 100 and 200. The chosen length of any moving averages is referred to as a look back period, which is a very important factor in how effective your strategy might be,
Along with the simple and exponential moving averages, there are certain other technical indicators which can help formulate an effective strategy. The exponential moving average in its own right provides more weight to recent trends as compared with the simple moving average. That helps to make when to plug and when to pull back but taking that decision alone without considering trendlines and momentum indicators may not be the best move.
The average directional index which is better known as the MACD (moving average convergence divergence) refers to an indicator which is able to forecast the change in price and its direction before it happens. In other words, any forthcoming changes in market direction are accurately forecasted using the MACD. This is used to know whether the market has topped(resistance) or floored(Support). Many forex trading software also give their traders the option of using moving averages with the use of them and make it easy for both the investor and the trader.
The other useful tool that works online with moving averages is known as trendlines, these trendlines help indicate whether the market has entered a range where it’s trending or ranging. That coupled with the EMA and directional indices help formulate a workable forex strategy.