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Moving Averages

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Chapter 6

Moving Averages

 

6.1 Moving Average

It filters out or smoothes the candle fluctuations and provide an average of the price. You assess the direction of the trend. Moving average is the average price of the pair for “x” number of period. The word moving means, the line formed by continuation of adding current average and removing last average from the data point set of whatever period you are on whatever time frame you have set this indicator. Many different moving averages are used but the 2 most common are simple moving average (SMA) and Exponential moving average (EMA). Example and explanation ahead for calculations of these moving averages. Whatever may be the calculation it's not that you have to calculate and plot the line; these days it's done with a click of a button on any broker platform.

 

6.2 SMA

Simple Moving Average is simplest of all. It is truly the average price of the pair for “x” number of period. Means a simple moving average is calculated by adding up the last “X” period’s prices and then dividing that number by X. what type of price to select depends upon the source you have selected means open price, close price, etc. discussed later in this topic.

For example, on a daily time frame SMA for 5 periods at candle “A” in chart EURUSD below will be average price of 4 previous candles plus including 5th current candle price at A below shown in red circle. You should note here that for easier depiction for you, where price point of moving average is formed a red horizontal line & red arrow is marked and the moving average price is highlighted by red circle.

The next price point of moving average is formed at candle “B” with average prices of 4 previous candles including 5th current candle price at B below shown in blue circle. You should note here that for easier depiction for you, where price point of moving average is formed a blue horizontal line & blue arrow is marked and the moving average price is highlighted by blue circle. This means the calculation removed the last one and added the current candle price.

Similarly, the Next price point of moving average is formed at candle “C” with average prices of 4 previous candles including 5th current candle price at C below shown in the green circle. You should note here that for easier depiction for you, where price point of moving average is formed a green horizontal line & green arrow is marked and the moving average price is highlighted by green circle. This means the calculation removed the last one and added the current candle price.

So by joining these price points calculated for moving average, the moving average line is formed.

 

(Sourced from www.Tradingview.com)

 

6.3 EMA (Exponential Moving Average)

The formation of the EMA is the same as described above in the SMA section except the calculation of the price point for exponential moving average. For exponential moving average the calculation used is following:

EMA= [Current Price x (2 /(1+N))] + [(previous period EMA) x (1- (2 /(1+N))]

In simple terms, EMA places a greater weightage on the most recent data points very similar to the weighted moving average. You can see below in chart that EMA points for candles A, B & C are described by red, blue and green circles. With red line moving average is Exponential Moving average.

(Sourced from www.Tradingview.com)

Difference between SMA & EMA

Also note that Exponential moving average is aligned more closely to candles than SMA.

That is why this average is preferred over SMA. For short term day trading its recommended to uses EMA as it assigns better weightage to current price movements in the market.

Also, keep in mind that this is a lagging indicator and not a leading indicator.

Trading solely based on EMA or SMA is not the right choice, other confluencing factors shall be considered as well.

 

6.4 MA Source (Close, HLC & OHLC)

As described earlier moving average is the average price of the pair at that point in time but what type of price to select for charting depends upon the source you have selected means open price, close price, etc.

Most common sources used are High, Low, Open Close & the combination of these. Now what does this mean, so let's check-

High means the price selected for moving average is “High” price of the candle on the time frame you are adding this moving average to.

Low means the price selected for moving average is the “Low” price of the candle on the time frame you are adding this moving average to.

Open means the price selected for moving average is “Open” price of the candle on the time frame you are adding this moving average to.

Close means the price selected for moving average is “Close” price of the candle on the time frame you are adding this moving average to.

Most commonly used are Close, HLC & OHLC.

 

Close is just mentioned above. Reason “Close Price” selection is favored over all other that it is confirmation of the type of candle this price has formed.

HLC price is a combination of High, Low, Close prices based on following formula –

Moving average Price Point = (High Price + Low Price + Close Price) / 3.

This is used by many institutional traders who believe that HLC is more closer representation of the candle price than all others. It is preferred over OHLC.

OHLC price is a combination of Open, High, Low, Close prices based on following formula –

Moving average Price Point = (Open Price + High Price + Low Price + Close Price) / 4.

Some institutional traders prefer OHLC price in contradiction to believers in HLC as being a better representation of the candle price than all others. But most of them use HLC as open price is considered historical.

In my experience, the “Close” price fits best for retail traders for moving averages.

How these MAs help in trading is described in chapter 8 “Strategies”.

Watch this Surplus Forex video to understand forex terms you need to know.

This is how far you have read and hopefully grasped the basics of forex.

Now move on to next steps to ensure you understood the forex trading relevamt aspects of these fundamentals

Seems easy, Right? Lets see how you fair…

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