Moving Average

One of the simplest forex indicators to understand is the moving average. You probably know that an average is sum of a given series of numbers divided by that set of numbers: 1+2+3+4+5 divided by 5.

In the case of forex trading, you take a given period of time, say one hour, and you take a specific number of hours, take the sum of the prices of the currency pair for each hour, and then divide by the set of numbers.

The moving average that is the result smooths out price movement, erasing the volatility, so that the trader can spot a trend.

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Some traders also use the exponential moving average. The exponential moving average is actually a weighted moving average, meaning that it gives greater weight to the recent days’ prices.

This makes sense given that they are more likely to be accurate than older prices – in a long moving average, very old prices get the same weight as almost new ones.

The weighting applied to the most recent price depends on the number of periods in the moving average.

How To Calculate The Moving Average

There are three steps to calculating an exponential moving average.

  1. First, calculate the simple moving average.
    • An exponential moving average has to start somewhere so a simple moving average is used as the previous period's exponential moving average in the first calculation.
  2. Second, calculate the weighting multiplier.
  3. Third, calculate the exponential moving average.

So, for example, for a 10-day exponential moving average:

Simple Moving Average: 10 period sum / 10

Multiplier: (2 / (Time periods + 1)) = (2 / (10 + 1)) = 0.1818 (18.18%)

Exponential Moving Average: {Close - EMA (previous day)} x multiplier + EMA (previous day)

You won’t have to make these calculations, as it will be available on the forex platform to plug in and do it for you. 

Observation of price movements with respect to moving averages often is useful – for example, a given pair will break higher or lower after crossing the 200-day moving average.

Traders watch for these patterns which are often remarked in forex commentary.

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