Moving averages is one of the many technical indicators which is used to show the average price of an instrument over a period of time. Moving averages measures the momentum of the price and defines support and resistance levels for the instrument. It is a great technical analysis tool that points out the direction of a trend.
There are many resources available that go into what the moving averages are made up of and how it is calculated. This article basically outlines only what you need to really know about moving averages and also how you can make use of this free forex indicator to identify support and resistance levels including the trends. Making use of moving averages, traders would be able to gauage the price direction and thus place their orders accordingly.
Before we go further into using moving averages, there are basically two kinds of moving averages you should be aware about.
Simple Moving Average
Obvious by its name, simple moving average is calculated as a the average price of an instrument’s closing price over a period of time.
So for example, a 10 day moving average would be the sum total of the closing price of an instrument, divided by 10.
To further simplify SMA, it is nothing but the average price of an instrument for a specified period of time (in this case, average price of an instrument for a period of 10 days).
It is also important to note that the term ‘Moving average‘ is usually referred to an SMA.
Exponential Moving Average
Obvious by its name, the EMA is calculated exponentially over a given period of time. It makes use of the SMA as a starting point and makes use of a multiplier (which is the weight given to the recent price) which is nothing but the number of periods in the moving average.
Using SMA and EMA for trade decisions
While there are many different ways to make use of the SMA and EMA, one good way to make use of these technical indicators is to use a 10 day SMA over a 30 day EMA or a 9 day SMA and a 26 day EMA.
Due to the nature of the average pricing of both, traders tend to open long positions with the 10 day SMA crosses over the 30 day EMA and open short positions when the 10 day SMA crosses below the 30 day EMA.
Refer to the chart below to see how the 10 day SMA and 30 day EMA plots BUY/SELL positions.
While the above set up is ideal for intra-day trading, traders also make use of the 200 day moving average. This is used for swing trading and works on the concept to define bullish and bearish markets. For example, traders focus on long positions when the current price moves above the 200 day moving average and focus on short positions when the price falls below this line. In the above chart, the 200 day SMA is the silver line. As indicative, it clearly outlines the bullish and bearish runs on the instrument (SILVER).
EMA’s and SMA’s form the critical elements of the MACD which is used as an indicator by many traders.
The above chart set up works perfectly find with 15 minute charts, up to 1 hour charts.