October 16, 2017
Moving averages are probably the most popular technical tool in forex trading. They are used to identify trends in currency pairs, and also as dynamic support and resistance levels. The most commonly used moving average settings in the forex market are the 50-day, 100-day and 200-day MA, which are followed by many market participants and thus represent significant support and resistance levels. Shorter periods can also be used, but they can create an MA indicator which is more volatile and reacts more quickly to price changes.
The most common types of moving averages used in the forex market are the simple moving average (SMA), and the exponential moving average (EMA).
Simple Moving Average (SMA) Explained
A simple moving average (SMA) represents the average price for a given periods of time. For example, a 20-day SMA will plot the average price for the 20 previous closing prices. When the most recent candlestick closes, the 20-day SMA will exclude the last candlestick from its calculation and include the new candlestick’s closing price. All periods have an equal weight in the calculation of the simple moving average. A chart with an SMA plotted on it is presented in the following graphic:
Simple moving averages give the same weight to older price actions as they do to more recent price actions. To solve this problem, traders use the second type of moving averages – the exponential moving average (EMA).
Exponential Moving Average (EMA)
An exponential moving average (EMA) is very similar to an SMA, except that EMAs give more weight to recent prices. This means that EMAs react faster to price changes than SMAs. Here is the same chart as above, except that the 20-day SMA is replaced with a 20-day EMA.
As you can notice on the chart above, an exponential moving average changes its direction faster than a simple moving average in times when the price makes new highs and lows. This is an important characteristic as recent price action is more significant to a trader than past price actions.
Simple vs. Exponential Moving Average – Which is Better to Use?
It’s important to note that moving averages are lagging indicators in their nature. This means, by the time a moving average changes its direction the price has already made its move, and more often than not the perfect entry point has already passed. Unlike SMAs, EMAs reduce this lagging effect to some extent as they give more importance to recent price changes. Like other lagging indicators, moving averages are best used to confirm an up- or downtrend and to indicate the strength of the move in price. In this regard, exponential moving averages will give a more accurate result than simple moving averages.
Test Your Knowledge: Moving Averages
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Question 1 of 3
Which of the following is NOT a commonly used moving average setting in the Forex market:Correct
Question 2 of 3
A simple moving average (SMA) representsCorrect
Question 3 of 3
What type of indicator is the moving average:Correct