Moving average is one of the most popular and easy to use tools available for doing technical analysis. It means the average price of a currency over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations. Moving average data is used to create charts that show whether a currency’s price is trending up or down. They can be used to track daily, weekly, or monthly patterns. Each new day's (or week's or month's) numbers are added to the average and the oldest numbers are dropped, thus, the average "moves" over time. In general, the shorter the time frame used, the more volatile the prices will appear, so, for example, 20 day moving average lines tend to move up and down more than 200 day moving average lines. There are four different types of moving averages: Simple (also referred to as Arithmetic), Exponential, Smoothed and Linear Weighted. Moving averages may be calculated for any sequential data set, including opening and closing prices, highest and lowest prices, trading volume or any other indicators. It is often the case when double moving averages are used.
The only thing where moving averages of different types diverge considerably from each other is when weight coefficients, which are assigned to the latest data, are different. In case we are talking of simple moving average, all prices of the time period in question are equal in value. Exponential and Linear Weighted Moving Averages attach more value to the latest prices. The most common way to interpreting the price moving average is to compare its dynamics to the price action. When the instrument price rises above its moving average, a buy signal appears, if the price falls below its moving average, what we have is a sell signal. This trading system, which is based on the moving average, is not designed to provide entrance into the market right in its lowest point, and its exit right on the peak. It allows acting according to the following trend: to buy soon after the prices reach the bottom, and to sell soon after the prices have reached their peak. Moving averages may also be applied to indicators. That is where the interpretation of indicator moving averages is similar to the interpretation of price moving averages: if the indicator rises above its moving average, that means that the ascending indicator movement is likely to continue: if the indicator falls below its moving average, this means that it is likely to continue going downward.
Simple Moving Average (SMA)
Simple Moving Average is the simplest type of moving averages. Basically, SMA is calculated by adding the last number in the period from the closing price, and then dividing that number with a period. Let me explain in example, if you select SMA 5 on a 1 hour graph, add the closing prices for the last 5 hours, and then divide that number by 5. If you select SMA 5 on a 30 minute graph, you will add the closing prices for the past 150 minutes (30*5), and then divide that number by 5. In the same way you can calculate SMA for any time period.
Most of the trading platforms will make all these calculations for you. The reason why I am bothering you with this component of technical analysis is because it is extremely important to understand how to calculate the moving average. If you understand how every moving average is calculated, you can make your own decision, which type is the best for you.
Like any other indicator, SMA works with a delay. Because you observe the average price, you are actually looking at the "forecast" of future prices, not the concrete future. Here's an example of how moving averages reduce the price activity:
On the previous chart you can see 3 different SMA. As you can see, the bigger period SMA you take, the more it stays behind the more prices. You probably noticed that the 62 SMA is much further away from current prices then 30 and 5 SMA. This is because with 62 SMA you are adding closing prices from the last 62 periods and dividing it with 62. The higher the number of periods that you are using, the slower is reaction to the movement of prices. SMA on this graph shows the overall sentiment in the market in a given period. Instead of just looking at the current price on the market, moving averages provide a broader view, and give us the general prediction of prices in the future.
SMA = SUM (CLOSE, N)/N ; Where:
N = number of calculation periods
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