forexlessons.org

Simple Moving Average (SMA)

Table of Contents

The SMA is the easiest to construct. For its estimation, first the courses of closing for the last n periods are summed up and then the result is divided by n. In practice, the result is an average course for these n periods, which is plotted on the graphics. The course of every following period is added to the sum of the previous ones, and the course of the most distant period is subtracted. Then the new sum is divided by n. This method ensures the “movement” of the indicator.
For example, a SMA for five-day periods will be estimated after adding the courses of closing for the last 5 days and dividing the sum by 5.

Exponential Moving Average (EMA)

In order to decrease the delay of the SMAs, the technical analysts sometimes use exponential (or exponential weighted) moving averages. They reduce the delay as they carry away more weight to the nearest in time courses. This weight depends on the magnitude of the moving average’s period. The shortest period we use, the bigger weight is given up to the nearest course.
Examples.
At a given EMA, estimated for 10 periods, the weight of the running course is 18.18%.
At a given EMA, estimated for 20 periods, the weight of the running course is 9.52%.
EMA = [K x (C – P)] + P, where:
EMA – an exponential moving average for the running period;
C – The course of closing of the running period;
P – The value of EMA of the previous period;
K – The smoothing constant (could be also meet as EMA %)
For estimation of the first value of the EMA a SMA is used. The smoothing constant applies the respective relative weight of the running course in relation to the value of EMA of the previous period. The formula for K is:
K = 2/(1 + N), where:
N – the number of periods, used for estimation of an EMA
At a given EMA, estimated for 5 periods, the weight of the running course is 33.33%.

Weighted Moving Average (WMA)

The WMA gives away bigger weight to the nearer data. The weight is based on the number of periods for the estimation of the smoothing average and it uses the sum of the given periods.
Example: For estimation of the smoothing average for 5 periods at a day period:
The sum of the days = 1 + 2 + 3 + 4 + 5 = 15
The example is illustrated in the following table.
Characterization and application of the Moving Averages
The Moving Average (MA) is a trend indicator, which makes easier the analysis of the trends by smoothing the hesitations in the values of the serial course data.
For its estimation, it is used data of the previous periods and therefore it is known as a trend, falling behind indicator. The smooth averages do not predict change in the trend, but follow the running trend. For that reason, they are most appropriate for trends identification and their following.
Characterization
The MAs act best when there is a clearly definite trend of the course movements and they are inefficient when the currency trading courses hesitate within the bounds of a definite range.
Having this in mind, before analyzing with the help of a MA, every trader should first identify the currency couples, whose course hesitations have trend characterizations in the given time range.
Therefore, there is no need of a scientific research, but a simple visual judgement of the currency couple’s price graphics. Generally speaking, the currency course could do one of the following three things: to move up (a rising trend), to move down (a decreasing trend) or to hesitate in a definite range. A rising trend exists when a given currency course does a series of higher peaks and higher bottoms.
An established decreasing row is seen when the currency course forms a series of lower bottoms and lower peaks. There is a market range when there could not be established a presence of a rising or a decreasing trend. If the currency course is traded in range, for a beginning of a rising or a decreasing trend, we can count a respective break of the upper or lower border of the definite course range.
After we are sure that the course hesitations read the trend characterizations of the analyzed time period, the next step is to choose the type of the MA and the number of periods, needed for its estimation. The number of the periods will vary depending on the volatility of the analyzed currency, its trend characterizations and the personal preferences of the individual trader. A higher volatility requires a greater “smoothing” and therefore a bigger number of periods for the estimation of the MA. A bigger number of periods is used when analyzing currencies, which do not show clear trend characterizations of the analyzed period.
There are no definite ciphers for a number of periods, which could be used, but some of the most common periods include 21, 50, 89, 100 and 200 days, as well as, 10,30 and 40 weeks. Traders, who trade in a short-term, could use a 21-day MA for identification of a 2-3-weekly trend, while these, who trade in a long-term, could follow 3-4-monthly trends with the help of a 40-day MA.
The method of try outs and faults is usually the best way for determination of the optimum number of periods. For that purpose, the MA is inscribed into the graphics. If there are many crossing between the indicators and the courses, the sensitiveness of the MA should be reduced by increasing the number of the used periods. If the MA reacts slowly, respectively we will reduce the number of the periods in order to increase its sensitiveness. In addition to this, we could choose between using a simple (arithmetic) or an exponential moving average. The EMA reacts faster to the market changes and is the most suitable for short-term movements’ analyses. The SMA reacts slowly and it s used for long-term prognoses.
Application
MAs are used basically for the following purposes:

Identification/ Confirmation of the trends
There are three ways for trade identification, using MAs:

The first method uses the direction of the MA for determination of the trend. The direction could be defined with a simple eye while observing the graphic image of the indicator. If the MA rises, we consider the trend for a rising one. If it decreases, then there is a decreasing trend. In both cases we would not like to react to every insignificant change, but only to the significant changes in the MA direction.
The second and most popular method compares the relation between the course values’ moving average and the course values themselves.
If the course values fall upon the MA, the trend is rising. And if the course values are under the MA, the trend is decreasing.
The third method for trend identification is based on the mutual position of the two moving averages. For that purpose, two MAs with a different number of periods are constructed on the course graphic. The trend is rising if the shortest (spanning the shorter time period) MA has crossed and is now situated over the longer (spanning the loner time period) MA. The trend is decreasing if the shorter MA has pierced and is now situated under the longer MA.
Identification/ Confirmation of the support and resistance levels
Other popular technique uses MAs for indication of eventual support and resistance levels. For that purpose, it is usually used one MA and its curve serves likewise to the support and resistance lines in the classic treatment of the technical analysis.

Using of a Simple (arithmetic) moving average

This is the simplest system, using MA for signals generation. It is advisable for it to combine with other instruments of the technical analysis for market range identification. This aims avoiding loss in consequence of the frequent crossing of the course values with the MA’s curve.
Signals for trading
The signals are generated when the course values cross the MA.
Long positions reveal when the course crosses from below upwards the MA.
Short positions reveal when the course crosses from upwards below the MA.
Signal filtration
The filters are used for elimination of the insecure signals. They objectively show if the course crosses the MA.
Used filters:

Long positions are revealed if the course crosses from below upwards a rising MA. Short positions are revealed if the course crosses from upwards below a decreasing MA. Different combinations of these filters could be used.

Using of two Moving Averages

Filtration alternative
There are used fast (for a shorter period) and slow (for a longer period) MAs as a measuring of the power and the direction of the trend. The fast MA is used for smoothing the course line and the number of periods at a fast MA conforms to the analyzed and traded cycle.
And this system, as well as the using of one MA, shows the same weakness – when there is a range, it generates faulty signals.
Trade Signals
They are generated when there is a mutual crossing of the two MAs.
Long positions are revealed when the fast MA crosses the slow MA from below upwards. Short positions are revealed when the fast MA crosses the slow MA from upwards below. The identification of the two MAs on the graphic happens as we compare the marked peaks and bottoms. The fast MA reads higher peaks and bottoms.

Using of three MAs

This system is used for identification of markets without a trend, which are better to avoid because of the faulty signals, generated from the trend indicator.
Signals for trading
Three MAs are used: fast, intermediate and slow. The positioning levels are determined by the crossing of the slow MA by the intermediate one. And the going out from an open position takes place as it is followed for a crossing of the intermediate MA by the fast MA.
Necessary and sufficient conditions for opening of long positions:

An open long position is closed when the fast MA pierces from below upwards the intermediate MA.
Necessary and sufficient conditions for opening of short positions: