Technical Analysis - Moving Averages
Moving averages is one of the most useful of a number of different charting tools, you can use to forecast future Forex prices.
The simple moving average is calculated by dividing the sum of the past N period, closing prices by the number of periods. Moving averages all operate with a delay, because you are using price data from the past to try and forecast what will happen in the future. (N.B. There is no absolute guarantee that past trends will continue into the future.)
For example, suppose you want to plot the 5 period simple moving average on a 30 minute chart. This will be the average of the closing prices of the last five, 30 minute periods. (Your charting software will do all of this for you, the examples below are for information only.)
Examples of Simple Moving Average calculations for the GBP/USD currency pair:
| 10 Minute | 30 Minute | 1 Hour | |||
| Time | Quote | Time | Quote | Time | Quote |
| 10:00 | 1.9722 | 10:00 | 1.9722 | 10:00 | 1.9722 |
| 10:10 | 1.9723 | 10:30 | 1.9726 | 11:00 | 1.9730 |
| 10:20 | 1.9725 | 11:00 | 1.9730 | 12:00 | 1.9732 |
| 10:30 | 1.9726 | 11:30 | 1.9731 | 1:00 | 1.9720 |
| 10:40 | 1.9728 | 12:00 | 1.9732 | 2:00 | 1.9716 |
| SMA | 1.9725 | SMA | 1.9728 | SMA | 1.9724 |
- The 5 period moving average on a 10 minute chart for the GBP/USD currency pair = 1.9725.
- The 5 period moving average on a 30 minute chart for the GBP/USD currency pair = 1.9728.
- The 5 period moving average on a 1 hour chart for the GBP/USD currency pair = 1.9724.
The longer the period you use to calculate your moving average, the smoother the chart. However, the longer time period also makes your moving averages slower to react to price changes. This is especially the case with simple moving averages, where the contributions to the moving average is the same for all the individual periods.
A single moving average is of little use. In order to find the price trends in the Forex market you need to plot a series of moving averages.
Exponential Moving Averages (EMA)
Simple moving averages are a very good tool for quickly establishing Forex market trends. However, they are very susceptible to spikes, and also rely just as much on older prices as newer prices. In your Forex technical analysis you need to base your forecasts on the most recent prices available. In other words you need to base your forecast on what traders in the Forex market are doing right now, not on what they were doing yesterday, or last week, or last month.
Exponential moving averages give us a method of placing more emphasis on recent currency quotes, than on earlier quotes. Suppose the daily closing prices for the GBP/USD are:
| Day1 | 1.9722 |
| Day2 | 1.9727 (1.9650) |
| Day3 | 1.9737 |
| Day4 | 1.9742 |
| Day5 | 1.9747 |
The 5 period simple moving average, on a 1 day chart is 1.9735. This is higher than the price on Day1 and suggests a rising trend for the GBP/USD pair. Now, suppose the quote for Day2 was 1.9650, perhaps due to an interest rate change by the Bank of England. The simple moving average would then be 1.9720, pointing to a downward trend for the GBP/USD currency pair. (Although the price has since increased consistently from Day2 through Day5.)
The answer is to use the exponential moving average that places more emphasis on the more recent prices. In other words, the exponential moving average, places more reliance on what the market is doing now.
In the above example, with Day2's closing price at 1.9650, the exponential moving average would be 1.9723, with a weighting factor (a) of 0.1, and 1.9726, with a weighting factor of 0.2. (The higher the weighting factor, the more the emphasis on recent prices).
You need not be concerned with the nuts and bolts of calculating exponential moving averages, because your charting software should do all this for you.
