What is Moving Average?
A moving average is a technical indicator that market analysts and investors may use to determine the direction of a trend. It sums up the data points of a financial security over a specific time period and divides the total by the number of data points to arrive at an average. It is called a “moving” average because it is continually recalculated based on the latest price data.
An important thing to note about the moving average is that it’s a lagging indicator. This means that it’s based on past price action.
Types of Moving Average
The 2 main types are Simple Moving Average and Exponential Moving Average.
Simple moving average calculates the overall mean of a currency pair’s movement whereas the exponential moving average gives greater weight to more recent price action.
How to use Moving Average?
There many ways MA can be used, below are the 4 main ways:
- Identifying the Trend
- As Support and Resistance
- Identifying overstretched market
Identifying the Trend
The 2 most common variation is the 10 EMA and 20 EMA. The steeper the MA, the stronger the trend. As shown in the below picture:
The pink line is the 10 EMA where the blue is the 20 EMA, simply with this, it enables us to see the trend direction of the market, so once we saw the market as bullish, we look for buying opportunities. On the other hand, when the market is below the EMA, it is a bearish market, and we look for selling opportunities.
As Support and Resistance
MA can also serve as dynamic Support & Resistance.
And because many traders pay attention to them they tend to become self revealing prophecies.
Here are some the most MA used:
- 10
- 20
- 50
- 100
- 200
Identify Overstretched Market
Since MA tends to serve as market mean, price tends to revert back to the mean when it has extended too far away from it
One of the more common pitfalls among Forex traders is buying or selling too late. We want to avoid entering a market that has overextended itself and moving averages can help us determine if this is the case.
Knowing MA can help us to time our entry and avoid buying at high prices or selling low prices. Instead waiting for price to pull back to the MA and get a better entry.
