We come across different types of moving averages, which are based on the way these averages are computed. Still, the basis of interpretation of averages is similar across all the types. The computation of each type set itself different from other in terms of weightage it lays on the prices of the currencies. Current price trend is always given a higher weightage. The three basic types of moving averages are viz. simple, linear and exponential.

A simple moving average is the simplest way to calculate the moving price averages. The historical closing prices over certain time period are added. This sum is divided by the number of instances used in summation. For example, if the moving average is calculated for 15 days, the past 15 historical closing prices are summed up and then divided by 15. This method is effective when the number of prices considered is more, thus enabling the trader to understand the trend and its future direction more effectively.

A linear moving average is the less used one out of all. But it solves the problem of equal weightage. The difference between simple average and linear average method is the weightage that is provided to the position of the prices in the latter. Let’s consider the above example. In linear average method, the closing price on the 15th day is multiplied by 15, the 14th day closing price by 14 and so on till the 1st day closing price by 1. These results are totaled and then divided by 15.

The exponential moving average method shares some similarity with the linear moving average method. This method lays emphasis on the smoothing factor, there by weighing recent data with higher points than the previous data. This method is more receptive to any market news than the simple average method. Hence this makes exponential method more popular among traders.

Moving averages methods help to identify the correct trends and their respective levels of resistance.

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What does Moving Average mean?

A moving average is defined as dividing the sum of two or more figures by the number of figures. In trading, that means adding up the price inputs for a given number of time periods and then dividing the sum by the number of time periods. Thus:

(Price 1 + Price 2)
————
n

where n = the number of time periods.
Calculating simple moving averages can be useful for trend analysis and even in advanced computer trading systems. They are also used for identifying levels of support and resistance. Traders can use one moving average or combine a few different ones to overlay on their charts. By using short-term, intermediate-term, and long-term averages on top of a chart, you can see the
trend direction of market prices from a different perspective. Typical time periods for multiple moving averages are 4, 9, and 18 periods, but today’s software allows you to use any number of periods you want.

What are the MA types?

There are four (The well-known) type of Moving Average indicators:

Simple
Exponential
Smoothed
Linear Weighted

Simple Moving Average – SMA:

The Simple (Arithmetical) Moving Average is the simplest version yet the widely used one.
It calculates the average of the price by adding the prices of the specified period together then divides it by the number of the prices. For example the Moving Average of the last 50 days closing price is the addition of these prices divided by 50.

The SMA indicator gives all the values the equal weighted and that’s the different between it and the other types of moving average (and that’s what distinguish between one type from another).

Let’s give a look for a SMA of 20 days on the EURUSD daily chart.

I’ve mentioned above the closing price as the applied price for the Moving Average calculation; This is not the only price the Moving average can use, Moving average can use one of these prices kind:

Opening Price:
The instrument open price of the calculated period

Closing Price:
The instrument close price of the calculated period

Highest Price:
The instrument highest price of the calculated period

Lowest Price:
The instrument lowest price of the calculated period

Median Price:
The instrument median price of the calculated period, this price calculated as following:
Median Price = (High price + Low price) / 2

Typical Price:
The instrument typical price of the calculated period, this price calculated as following:
Typical Price = (High price + Low price + Close price) / 3

Weighted Price:
The instrument weighted close price of the calculated period, this price calculated as following:
Weighted Price = (High price + Low price + Close price + Close price) / 4

Exponential Moving Average – EMA:

Exponential moving averages are calculated from complex formulas and have become the most common averages used today by many quote vendors, analysts, and traders as they also are weighted to give more importance to the latest data from current market conditions, and older data that becomes less important as time passes are eventually filtered out.

Smoothed Moving Average – SMMA:

The Smoothed Moving Average indicator smoothes the Moving Average by giving the recent prices an equal weighted to the historic ones. It recommend to use the SMMA with long period to get better result.

Linear Weighted Moving Average – LWMA:

Linearly weighted moving averages can be calculated by taking, say, a five-day time period and multiplying the close of the last time period by five, multiplying the close of the previous time period by four, multiplying the close of the time period before that by three, and so on. Add the sum of all five time periods and then divide by five to get a weighted average that gives more significance to the most recent price action.

How to trade using Moving Average Indicators:

Actually studding the usage of Moving Average indicators in trading Forex needs a whole book but we try to know the most used usage of MA briefly in this section.

The important rule to bear in your mind is thatâ€‌ Where’s a trend where’s the Moving Averageâ€‌ which means the Moving Average work better in the trend market and they act bad in the time of fluctuations of the market

Moving Average Breakout:

In this method we need to plot a Moving Average Indicator on the chart (i.e. 24 hours LWMA on EURUSD Hourly chart).

When the price crosses the Moving Average down-up and there’s a complete candlestick above the Moving Average indicator we Buy.
When the price crosses the Moving Average up-down and there’s a complete candlestick below the Moving Average indicator we Sell.

Moving Averages Crosses:

In this method we need two (or more) Moving Average Indicators; The first one will be set with a small period (It called the Fast Moving Average) and the second one will be set with bigger period (It called the Slow Moving Average). i.e. 10 days EMA and 80 days EMA on EURUSD Daily chart.

When the Fast Moving Average crossed the Slow Moving Average down-up we Buy.
When the Fast Moving Average crossed the Slow Moving Average up-down we Sell.

Moving Averages Channel:

In this method of trading we use two Moving Average Indicators which hardly could cross each others (i.e. The first Moving Average is 10-Period SMA of the price high and the second Moving Average is 8-Period SMA of the price low)
These indicators will plot upper and lower boundaries of the channel.

When the price crosses and a complete candlestick is above the upper boundary of the channel we Buy.
When the price crosses and a complete candlestick is below the lower boundary of the channel we Sell.

There are thousands of methods and settings the traders use Moving Average to implement everyday trading.

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