What is the Moving Average in Forex Trading?

Moving Average (MA) is one of the most essential and efficient indicators of technical analysis. The moving average calculation is valuable. It can be the basis for other technical analysis indicators, such as MA convergence divergence (MACD). Therefore, naming this indicator as a basis for several different indicators shows its importance more than ever.

All traders are trying to find a way to predict the upward or downward movement of the market. Moving Average is one of the simple tools used for technical analysis. Therefore, this indicator allows traders to detect and find the direction of trends by eliminating short-term price fluctuations.

In fact, by calculating the moving average, the effect of random and short-term fluctuations on the price of an asset over a period of time will be reduced. Thus, you will be able to investigate the average price over a specific period of time (In the MA indicator, the average price is calculated over a predetermined period of time).

For example, a 100-day moving average will record more latency than a 50-day moving average, so the longer the MA duration, the more the latency will be.

Different types of moving average

Moving averages are divided into two main categories:

1) Simple moving average (SMA)

This simple technical indicator is suitable for long-term trends due to its slow speed. It is obtained from the sum of the specified time period and their division by the total number of periods. For example, a five-day Simple Moving Average (SMA) sums the recent five closed prices and divides them by five to create a new average per day (You can also calculate the average of several specific time periods).

Each average is connected to the next, making a unique flow line. Traders use this index to generate a signal when entering or leaving the market by identifying support and resistance levels to determine the best entry and exit point. Since SMA is a backwards move, it refers to the past data over a specific period of time.

The method of calculating the simple moving average

SMA = (A1 + A2 + ………. + An) / n

• A = average period
• N = number of periods

For example, a stock trader wants to calculate the simple moving average of BMW stocks by closing stock prices over the past five days. The closing prices of this stock is as following for the last five days:

85.20, 84, 83.90, 82.29, 83.48

So, the SMA is calculated like this:

SMA = (85.20 + 84 + 83.90 + 82.29 + 83.48) / 5          SMA = 83.77

2) Exponential moving average (EMA)

The other type of moving average is called the exponential moving average. It assigns more weight and significance to the most recent prices. So, the EMA is more responsive than SMA, which applies the same weight to all price changes in a specific time period. That’s why most traders pay more attention to EMA. The 12-day and 26-day moving averages are used for short-term analysis and also the creation of indicators such as MACD and PPO. The 50 and 200-day moving averages are used for long-term trends. When the price crosses its own 200-day MA, it indicates a technical signal which means the trend is reversing.

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The EMA is also commonly used with other indicators to confirm significant market movements and measure their credibility. EMA is more beneficial for traders who like day trading and trade based on the rapid movements of the market. Traders often use the EMA to determine the direction of trades. For example, if an EMA shows a strong uptrend in the daily chart, maybe buying will be the only strategy of a day trader.

The method of calculating the exponential moving average

To calculate the EMA, first, we should calculate the SMA.

SMA = (A1 + A2 + ………. + An) / n

• A = average period
• N = number of periods

Next step is calculating the weighting multiplier:

(The number of selected time period + 1) / 2

(15 + 1) / 2 = 0.125   12.50%

Then we calculate the EMA:

EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier)

M= (N+1) /2

Using moving average

Undoubtedly, every trader enters financial markets to make a profit. Therefore, being aware of the most appropriate time to enter the markets will bring them more profit. To achieve financial goals in financial markets, using the right tools for that market is necessary. In the Forex market, using technical analysis is considered the most appropriate way to make a profit.

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But to use this type of analysis, you need a tool such as technical analysis indicators, which have three prominent types. The trend indicator that moves with the price trend; the oscillator that fluctuates to measure the strength of buying and selling and the saturation points of trading; and the volume indicator that shows the volume of trades. Each one of these indicators has different types that are used to detect market trends.

Identifying the resistance and support levels with MA

The most common use of moving averages, in addition to identifying trend directions, is determining support and resistance levels. Therefore, in an upward trend, 50,100 or 200-days moving averages may act as a support level. Because the average is like a price floor.

The price does drop below that level; however, the price goes above it. On the contrary, in the downtrend, the moving average may act as a resistance. At this point, the MA is like a price ceiling, and after encountering that, the price starts falling again.

Indicator position

This indicator is based on past prices and is used in long-term transactions. So, in terms of time, it is in the category of lagging indicators and in terms of determining the direction and continuity of the trend, it is placed in the category of trend indicators.

Conclusion

Moving average is the basis for other technical analysis indicators. Thus, it is a good method for traders who have no experience in Forex market analysis. On the other hand, it should be kept in mind that this method clarifies the price-performance but does not replace it. In brief, using this tool as a guide will help you make better decisions in the Forex market.