What Are Moving Averages?

A

verages, which are moving? Does it sound strange?

There is no room for you to worry! 

Moving averages are not some scary market indicators of a Margin call or Stop outs. 

As we know, these two are the scariest phrases among all Forex lingo.

This is not the case here! 

Moving averages are technical indicators, which actually help you to distinguish the trend direction from the false signals. 

When we say “moving average”, it is referred to the average closing price of a currency pair for the last ‘X’ number of periods.

Here is a chart with moving averages:

The moving average looks like a snake, which is sliding over the top of the price, represented by Japanese candlesticks.

It is called a “chart overlay“.

How does this moving average (MA) indicator help us forecast future prices?

Trends do not move in straight lines and the price is going zig-zag all the time. 

If we overlay a moving average, it will show you the clear underlying trend, instead of focusing on the random price movements.

By smoothing out the price action, you can determine easily the trend direction if you look at the trail this snake makes. 

There are different types of moving averages, which have different levels of “smoothness”.

Overall, the smoother the moving average, the slower it is to respond to the price movement.

The more jumpy the moving average is, the faster it is to respond to the price movement.

If you want to make a moving average smoother, you need to get the average closing prices over a longer time period.

How to Choose the Proper “Length” of a Moving Average?

It is essential to choose the right time period in the appropriate combination of indicators, which is consistent with the specifics of the market and the trader. 

The way your moving average is displayed on a price chart depends on its length.

When your line is short, it means that you have a small number of data points, included in the moving average calculation, which allows the moving average to be close to the current price.

This has its disadvantages such as giving less insight into the overall trend, rather than just the current price itself.

When the line is long, there are more data points, included in the moving average calculation, which means that a single price can’t significantly affect the overall average.

But be careful with gathering too many data points, because the price fluctuations may become “too smooth” for you to be able to determine the trend!

Therefore, it is truly necessary to choose the right length for your moving averages, which will provide the most suitable information for your trading time frame purpose. 

Remember that the Moving Averages do NOT predict price direction, they just show the current direction, but with a lag.

According to the calculation method, there are two main types of moving averages:

  • Simple moving averages (SMA)
  • Exponential moving averages (EMA)

If you learn how to incorporate these moving averages in your trading strategy, we promise you that your trades will go more smoothly than the skin smoothness of one of those models in Dove commercials. 

Go ahead to the next lesson to see how to calculate them and some pros and cons for each type.

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What is Simple Moving Average (SMA)?

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