The Moving Average Indicator is one of the oldest and most popular technical analysis tools. The Moving Average is the average price of a financial instrument over a given period of time. When applying the indicator, you can use different periods of time to calculate the average price. For example, it could be 14, 21 or 30 days. The Moving Average is an essential analysis tool for both Managed Forex Accounts, Forex Trading Signals, and it is among subjects discussed in the Training Course.
The Moving Average Indicator is calculated by adding the value of all prices over a specific period of time and then dividing the result by the number of these periods. For example, add the closing prices for a financial instrument over the last 20 days then divide the result by 20; the result is the average price of the financial instrument during the last 20 days. The average is called “moving” because the indicator either adds or subtracts prices in the equation and divides the result by the number of periods automatically as the price changes.
The most common classic way to interpret the Moving Average Indicator is to compare the dynamics of the Moving Average curves with the price movement of a certain financial instrument, which in this case will serve as support or resistance levels.
The second way for interpreting the Moving Average is understanding the meaning of the increase and decrease of the price above or below its average. When the price is higher than the Moving Average, it means that market participants’ expectations (i.e. the current price) are higher than the average prices during the last period, which effectively increased the price. Conversely, if the price is less than the Moving Average, it means that prices’ expectations are lower than the average of the previous period.
The advantage of trading using the Moving Average Indicator is that we are always on the “right side” of the price’s direction, as the indicator provides a continuous signal of the current trend: if the Moving Average is below the price, the trend is rising, and if it is above the price, then the trend is declining. It’s also possible to use the Moving Average to confirm the change in the direction of the price, which happens when the price breaches the Moving Average from one side to the other.
The Moving Average Indicator is not designed to provide signals for entering trades as the likelihood of the continuity of the price movement in the same direction and the possibility of returning to the Moving Average are equal since the price movement away from the Moving Average will remain limited. Consequently, it is very likely that the price breaches the Moving Average during a specific time period and then returns to what it was before the breach.
Also, Moving averages can be applied to other technical indicators as they are applied with prices.
There are four different types of Moving averages:
Simple Moving Average (SMA)
Exponential Moving Average (EMA)
Smoothed Moving Average (SMMA)
Linear Weighted Moving Average (LWMA)
The Moving Average Indicator can be calculated for any set of sequential prices, such as the opening and closing prices, the highest and the lowest, or any time-bound price value. Usually, these types are used when applying multiple Moving Averages on the same price chart. The key point that makes these averages differ from each other is the way of handling the weight, as different data values will lead to spacing between curves of the averages.