There are three fundamental types of moving averages commonly used in Forex trading: simple, weighted and exponential (These are commonly referred to as the SMA, WMA & EMA).
Today, I’ll explain how moving averages are calculated and used for in the Forex market.
Moving Average Trading Strategies in the Forex Market
The benefit of moving averages is that they reflect longer-term changes in the price, effectively smoothing out day-to-day volatility (of course there are cool volatility indicators which I’ll share with you soon).
The more periods you include in your moving average calculation, the smoother the average line will be. I’ll discuss the periods online forex traders generally use for each type of moving average indicator.
The Simple moving Average (SMA)
The simple moving average is calculated just as you would calculate an arithmetic average of anything (take the sum of the parts, then divide by the number of parts).
The arithmetic average is recalculated at the beginning of each new period such that the same number of periods are always included (for example, if I were to calculate a moving average based on 10 periods of data, as soon as a new period closed, I would add that to the calculation as the 10th period and drop what was the 1st period). In this way the average moves with the market.
The Weighted Moving Average (WMA)
A weighted moving average weights more heavily more recent price data (the more recent periods received a larger weight than older periods do). The weight changes from day to day in order to more heavily weigh recent data.
A weighted moving average, while somewhat more complicated than the simple moving average, can be more useful because it offers more information about recent movement (which, in turn, can offer more information about future movement).
The Exponential Moving Average (EMA)
Another type of weighted moving average is the exponential moving average. While the weighted average is calculated using different weighting factors determined by the trader, the exponential moving average is weighted by multiplying a percentage of the current period’s price by the previous period’s average price.
An exponential moving average can be a very useful tool in understanding the overall movement of the market over time, and in forecasting potential future movements.
Moving Average Trading Notation
In many Forex trading courses, seminars and books you’ll see the following notation:
- SMA(14) – a simple moving average calculated over the last 14 candles
- WMA(30) – a weighted moving average calculated over the last 30 candles
- EMA(60) – an exponential moving average calculated over the last 60 candles
This is a helpful way to show you how many periods the moving averages occur over. I also use this notation because it makes simple sense!
There are several different techniques that traders use with moving averages. Moving averages can be used as average price lines, which, if crossed, signal potential reversals. Moving averages can also be used together (two or more moving averages that incorporate a different number or periods) to generate buy and sell signals (this use is called moving average crossover).
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