Moving average to predict trend direction is the oldest form of technical analysis in Forex trading. It is one of the most used indicators and it is useful for reducing market noise or rate fluctuations which make the interpretation difficult. Moving averages smooth out those market fluctuations and make it easier to identify the potential rate trends of all currency pairs.
Traders want to find and identify a rate reversal point to time market the selling and buying at profit level. Moving average helps in both cases. This is essential for other types of technical analysis also.
Benefits
1. Smooth out the rate fluctuations of market that occur with every reporting period in a price chart. It occurs often.
2. More frequent the rate updates (more often the price chart shows an updated rate), the higher the market noise potential.
3. False signal are potential headaches for traders in a fast moving trend of market. The rate trend ‘ranges’ and ‘whipsaw’ or price volatility generates the false signal.
Reporting period vs moving averages
The moving average line on the price chart is affected by the number of reporting periods; these are included in the moving average calculation. The fewer the reporting periods in the average, the nearer the moving average stays to the spot rate and decreasing its value. Thus, it offers a bit more insight into the whole trend than the price chart itself.
Besides, a moving average which ensembles too many points evens the fluctuations in price and make it difficult to detect a rate trend.
In either case, it is tough to identify reversal points in enough time to take benefits of a rate trend reversal.
Different types of moving averages
To handle the market analysis, there are several types of moving averages.
1. Simple moving average (SMA)- Most basic and calculated by taking a price series or reporting periods. Then adding these prices together and dividing the total by the number of data points. It is calculated byadjusting in response to the most recent data.
2. Weighted moving average (WMA)- only uses values which are linearly weighted to make sure that the most recent rates have a higher impact on the average. More relevant in fast moving market.
3. Exponential moving average (EMA)- It is different from SMA in such a form that EMA removed calculates the average of all past ranges.
To determine which one is best for you, you need to understand the needs. For reducing noise, a SMA of the last 20 or so rates is handy.
Considered as an overlaying indicator, moving averages should be placed over some price chart.
