Moving Average - is the most simple and the most popular indicator which helps trader to indicate direction of the current trend.
Technical analysis.
Part 3. Mathematical methods
Lesson 2.
Moving Average
Our first lesson on mathematical methods of technical analysis will be devoted to the Moving Average (МА). This is the simplest and the most common indicator that belongs to the class of trend following: it helps to identify the direction of the current trend (for example, you have just turned on the computer and you need to understand the situation) and to determine the beginning of the next one (reflects the change of the trend). Many other indicators have been built on its basis.
How is МА calculated
The Moving Average is based on the average price indicators for a certain period.
The average price for the period is calculated by the program and is plotted as a point on the graph. As a result, we get a chain of points, that reflects the general direction of price, while smoothing all the occasional bursts.
Price indicators for calculation may be different: the opening or the closing price, the minimum or the maximum (on a time frame).
Period is a time interval equal to one time frame, i.e. if there are minutes time frame on the chart, then one period is one minute, if one hour - then an hour, etc. There are 1-, 5-, 20-, 50-, 100- and more period Moving Averages: their duration depends on the tasks of the conducted analysis and is connected to its depth. For a long-term trend analysis, take the longest periods - 100, 144, 200, to minimize statistical noises, for a medium-term one - 20-50, for a short-term analysis (for example, the situation within the day) take the minimum period - up to 20. A Moving Average with long periods is called slow, while with short ones is fast.
Interpretation of the Moving Average
― the price is above the Moving Average - the trend is upward (it is worth buying);
― the price falls below the Moving Average - the trend turns downward (it is worth selling).
Breakout of the Moving Average gives a strong trading signal:
― when the moving average crosses the chart from bottom to top, we get a buy signal («bullish» signal, long position), i.e. the price will increase;
― from top to bottom - for sale («bearish» signal, short position), this is an indicator of a price drop.
With the choice of the Moving Average period comes the term of sensitivity and reliability of this indicator:
― the shorter the period, the more sensitive and less reliable the indicator is, since it reacts sensitively to market changes and sometimes it can provide false signals;
― longer periods, on the contrary, are less sensitive to statistical noise, but may miss an important trading signal, because, due to the comprehensible calculation features, the Moving Average always lags behind the market, which is especially noticeable for long periods (say, for the 200-period option, the indicator will not be calculated until these 200 period pass, which is quite a lot, and the price can simply be calculated incorrectly after that time).
Therefore, setting up a period for MA is very crucial, you need to clearly understand what you want to get from the indicator.
Taking into account the features of various Moving Averages, traders often use several MAs, for example a combination of slow and fast. When several movings are used simultaneously, trading signals are generated.
How does it happen
For example, you can use the 50-period (medium-term) and 9-period (short-term) Moving Average.
Trade signals occur when they cross (see the principle of signal formation above).
Sell:
Buy:
It is important to note that the use of this indicator is appropriate only under clearly expressed trends. In a stable market, when there is no clear trend (the situation is called flat), the Moving Average can give many false signals.
The Moving Average is one of the oldest indicators in technical analysis. Over time, a few more modern options were invented.
The one we talked above is a basic indicator, a Simple Moving Average
(SMA), which is calculated by a simple formula: the average price of the instrument (currency pair) for a certain period.
More modern variations of the Moving Average take into account various factors that influence the price.
Thus, an exponential average (EMA) in its calculation assigns greater weight to new data, and the weight of the old data decreases (exponentially). Within this indicator, it is believed that the impact of more recent data on the current price is much stronger, and over time, the significance of old data decreases even more. Therefore, the calculation formula includes coefficients that take into account that reduction.
Triangular, or weighted, average also implies a decrease in the significance of older data, but within the context of this indicator the significance decreases strictly linearly.
The adaptive Moving Average pays more attention to changes in the market and the speed with which they occur, and assigns a different weight to data by the formula. Thanks to its calculation algorithm, it responds more effectively to market changes.
How to add MA to the chart on MetaTrader 4
In «Navigator» in MetaTrader4 find «Indicators» and then «Trend following», there you will find Moving Average.
Place the following settings:
― period;
― MA type;
― price field (opening, closing, lows, highs).
In your terminal, find the Moving Average indicator and try to build several different averages for your tool, observe their behavior, identify trading signals and practice transactions. Constant practice is extremely important when it comes to the usage of this analytical tool.
In the next lesson we will move on to the tool created on the basis of Moving Average, the MACD indicator, which, unlike all the averages, is a leading indicator, it reflects a change in the price trend.
