This article looks at the different types of FX moving averages and how to calculate them.
One of the most well-known and frequently used technical indicators is the moving average. This is a simple tool that traders can use to smooth out price movements of a given currency. As currency price movements can be rather volatile in a short-term condition, moving averages are used in order to identify the direction of the trend.
Calculating an FX moving average
The moving averages are calculated by dividing the average price of a currency by the number of days in a trading period. For example, a 50 day moving average would be determined by adding the prices of the currency over the past 50 days in a completed trade, then dividing that by 50.
While this can be done manually, nowadays there are technical FX trading charts to complete the calculation automatically. When established the moving average is overlaid onto the price chart allowing all traders to examine the smoothed data rather than focusing on the daily currency price fluctuations.
Adapting the FX moving averages
Due to the way a moving average is calculated, you are allows to adapt your moving average according to the trading time period. The most frequently used increments when customising these averages are 15, 20, 30, 50, 100 and 200 periods. A shorter moving average can be noted as being between the 15 and 50 time period and will closely mirror the price movement of an actual chart; whereas, the longer time period moving averages will not. This longer time period will present as more smoothed out and less sensitive. However, there is no correct time period and the presentation of the moving average is dependent on the trader.
It is generally seen that FX traders will consider intraday moving averages as part of their trading systems. For example, if you are looking at a ten minute forex chart, but want a five-period moving average you could adapt the prices in the previous 50 minutes and divide it by five to obtain a five-period moving average. As is mentioned the moving average is dependent on the trader; however, it is recommended you test various time periods before you settle on one to suit your trading strategy.
The simple moving average v. the exponential moving average
There are two types of moving averages – the simple moving average and the exponential moving average. The moving average discussed above is of the simple variety because it takes a number of periods and averages them for a desired time period. One of the primary drawbacks of a simple moving average is that it is vulnerable to large currency price movements. For example, imagine you are plotting a steadily rising five-day moving average, and then there is a sudden down spike causing the moving average to decline much lower with a downtrend by an unforeseen problem which is unlikely to reoccur. To mitigate this problem you may consider using an exponential moving average.
The exponential moving average gives more weight to recent market prices during calculation of the average. Therefore, if you are using the five-day moving average, this type of average would place greater emphasis on the end prices than the prices over the five days. If the illustrated spike caused a decline during the week the moving average would not have been affected.
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