What is a moving average in Forex trading? How does a moving average indicator in Forex help in trading? We need all the help we can get when it comes to trading. Whether stocks for Forex. With help, we get better entries and exits. Along with support and resistance. And when it comes to those things, we need to be right!
Table of Contents
What Is a Moving Average in Forex?
- The moving average in Forex is a technical indicator for analyzing the financial markets. If you look at the price charts, you’d notice that the price of an instrument continuously moves up and down. The price goes up only to fall moments later before it rises once again. Forex traders analyze the fast-moving prices to find entry and exit levels. However, the rapid price action also increases the possibility of a false signal to the traders.
The Helpfulness of Moving Averages
The moving average in Forex is a useful indicator to filter out false signals from sudden price fluctuations. The advantage of the moving average indicator is that it can help to identify the market trend and potential reversal points.
For example, if you plot moving average on an instrument and the price stays above the moving average line, you can say that the price is in an uptrend.
Conversely, if the price stays below the moving average line, you can say that instrument is in a downtrend. Finally, when the price breaks above or below the moving average you can take it as a trend reversal.
You can also use a moving average to identify the support and resistance levels. And plan your trades accordingly. Many traders also use the moving average indicator to see whether the price will break the moving average line or bounce back from it.
In short, the moving average is a handy technical tool to analyze a trending market and seek valuable information on trend direction and possible reversal.
It’s worth knowing that the moving average is a lagging indicator and is based on past prices. Therefore, it doesn’t provide advance indications. And only confirms the signal after the trend has changed on a basic level.
Types of Moving Averages in Forex
There are three types of moving averages in Forex and widely used in stock market analysis. The Simple Moving Average (SMA), Weighted Moving Average (WMA), and Exponential Moving Average (EMA).
Let’s first discuss the simple moving average and see how it’s calculated. Let’s assume that you want to plot a 7-day simple moving average on a chart.
If you’re using a trading platform it will sum up the last 7 days closing prices and divide by 7. The chart will now display a line showing the average closing price of the last 7 days.
Now you can use the simple moving average line to analyze the market and place your orders. Remember that you can also use the open, high, and low prices to calculate the moving average.
One disadvantage of the simple moving average is that it gives equal weightage to each period. Which makes it slower to respond to rapid price changes that are important for entry and exit.
So to counter this downside, there are other types of moving averages that are more sensitive to recent price action and respond faster than the SMA. These moving averages are weighted moving average (WMA) and the exponential moving average (EMA).
The WMA and EMA are calculated differently from one another. But both apply more weight to recent periods and less on the older periods.
As a result, WMA and EMA respond faster to price action. They reflect market sentiments more quickly that are changing due to supply and demand or a piece of related news.
To illustrate the difference between fast and slow-moving averages, you can plot simple and exponential moving averages together on a chart using the same timeframe. You’ll notice that the EMA is more sensitive and stays much closer to the current price than SMA.
Moving Average Time Frame
To analyze the market using the moving average you’ll also have to decide on a timeframe. The timeframe largely depends on your trading approach.
For example, if you want to analyze a long term trend you would select a longer timeframe to get a better picture. Keep in mind that the longer the timeframe the more reliable it is.
The common timeframe for short term trading is between 7 to 21. The timeframe for a medium-term trend is 50 while long term traders prefer a timeframe between 100 to 200.
Now, finally how do you decide which type of a moving average in Forex to use? If you’re trading short timeframes you can prefer EMA because it’ll emphasize more on the recent price action.
If you’re a long term trader or simply holding your position for a long time, the EMA will be too sensitive and might give you a false signal.
To avoid that, the simple moving average would be a better choice as it clears out the sudden price fluctuations.
In the next tutorial of the moving averages, we’ll discuss trading strategies using moving averages as well as combining two different averages and using their crossover as a signal.
Conclusion
To answer what is a moving average in Forex, you need to understand what they are and how they work. Traders have differing opinions regarding moving averages. As a result, pick what works best for you!
