Trend Indicators - Moving Average
Moving Average (MA) is the average of prices (more often the closing prices) over a specified number of periods. It is a smoothed correlation between currency rates and time periods. The time period of any moving average defines how much it will be smoothed. For example, when a Moving Average is calculated by adding the closing prices for the last 5 bars, then it is defined as a 5-period MA.
When you select a period for the moving average (table shown below) keep in mind the following:
- The greater the time period, the less sensitive the MA is to price movements.
- If the MA period is too short, then it will have too many false signals.
- A too long MA period will often lag short-term price movements.
- For sideways trends it is better to use longer time periods.
| Recommended Moving Averages time frames | ||
|---|---|---|
| Chart period | Moving Average | |
| Weekly | 8, 13, 21 | |
| Daily | 8, 13, 21, 55, 89 | |
| 4 hours | 8, 34, 55, 89, 144 | |
| 1 hour | 8, 34, 55, 89, 144 | |
| 15 minutes | 34, 55, 144 | |
There are three types of Moving Averages:
- Simple Moving Average (SMA)
- Weighted Moving Average (WMA)
- Exponential Moving Average (EMA)
Formula for the Simple Moving Average (SMA):
where
- P - price of i-bar;
- n - MA period.
Formula for the Weighted Moving Average (WMA):
where
- P - price of i-bar;
- W - weight of i-bar.
Often MA is weighted by volume.
Formula for the Exponential Moving Average (EMA):
EMA(t) = EMA(t - 1) + (K x [Price(t) - EMA(t - 1)],
where
- t - current time period;
- t -1 - previous time period;
- K = 2 / (n + 1);
- n - EMA period.
The main advantage of the Exponential Moving Average (EMA) is that it discounts both prices of the previous and current periods. Every subsequent value becomes more significant.
How to analyze Moving Averages:
- Find Moving Average and price chart cross-point. If the price line crosses the Moving Average line from below, then this is a signal to buy. If it crosses from above, then it is time to sell.
- Note that Moving Average usually moves in the direction of the prevailing trend.
- Find points which occur after Moving Average tops or bottoms. There is a high possibility of a reversal.
- Find points where the divergence between Moving Average and price is widest.
If you do not have other confirmations it is not recommended to open positions against the Moving Average's direction.
Moving Average signals are more effective on a trend market and less effective when the market is flat. As MA is a lagging indicator, it can often create false alarms.
