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Moving
averages is one of the most useful of a number of different
charting tools, you can use to forecast future Forex prices.
Simple
Moving Average (SMA)
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.)
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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:
Day 1:
1.9722
Day 2: 1.9727 (1.9650)
Day 3: 1.9737
Day 4: 1.9742
Day 5: 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.
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