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Trading using Moving Averages

Utility: Evaluating the Trend / Forecasting Trend Reversals

Combination: Moving Averages can be combined with RSI, ADX and other Indicators

 

Introduction to Moving Averages

Moving averages constitute the most common tool of technical analysis. Moving averages are mainly used to identify current trends and to forecast reversals. All traders can easily use a moving average no matter the level of their experience or their trading style. The great advantage of a moving average is its ability to eliminate the impact of ‘Market Noise’. Market Noise usually leads traders to false assumptions about the upcoming market conditions. If you compare the current price of a financial asset with the value of a moving average (for example 50 days MA) you get in just a glance a clear picture regarding if that asset is trading in overbought or oversold levels.

The use of moving averages is not limited to a few markets, instead moving averages can be used to analyze any market (Stocks, Forex, Indices, Commodities) and / or any financial-traded asset.

 

Basic Features of the Moving Averages

(1) Easy-to-use technical analysis tool, easy to assess results

(2) Signal trades in any financial market or asset (check crossovers below)

(3) Can be used in any timeframe (intraday, daily, weekly, monthly)

(4) Can confirm (or not) the results of other technical analysis tools (ADX, RSI etc)

(5) A moving average can be the sub-components of another technical analysis tool (for example RSI or MACD)

(6) Can draw beautiful charts or channels (check Moving Average Envelopes below)

(7) Eliminates the impact of Market Noise

(8) Can be used as components of automated trading systems (for example Forex Robots)

Create your Own MT4/MT5 Trading Indicators for Free

 

Trading Signals from Moving Average Crossovers

The crossovers of two moving averages or the crossover of the price of an asset can be used as a trading signal.

Moving Average Crossovers:

Moving averages can be used in pairs of a faster and a slower moving average. A crossover occurs when one of the two moving averages crosses the other.

■ Bullish crossover means that the faster moving average crosses above the slower moving average

■ Bearish crossover means that the faster moving average crosses below the slower moving average

Price crossovers:

This situation occurs when the price of an asset crosses above or below a moving average.

■ Bullish crossover means that the current price crosses above the moving average

■ Bearish crossover means that the current price crosses below the moving average

Note that these signals are valid only if the slope of the price chart and the slope of the moving average are moving in the same direction. You can check an example below this article.

 

Six (6) Main Types of Moving Averages

There are a lot of different moving averages that can be used:

Simple Moving Average (SMA)

Exponential Moving Average (EMA)

Weighted Moving Average (WMA)

Smoothed Moving Average (SMMA)

Triangular Moving Average (TMA)

Moving Average Envelopes

 

(1) Simple Moving Average (SMA)

The simple moving average or SMA is one of the most popular moving averages.

Calculating the Simple Moving Average

The SMA can be easily calculated and it is actually showing the average price of a financial asset during a certain period.

■ SMA = SUM of closing prices / number of periods

Example: If an asset for the past 3 days has the following closing prices:

1st day: $100

2nd day: $105

3rd Day: $110

Then the Sum of Closing Prices is $315 and the SMA = $105

($315 / 3 days = $105)

 

(2) Exponential Moving Average (EMA)

Moving averages such as the Exponential Moving Averages (EMAs) are more sensitive to recent price data than the Simple Moving Average (SMA). That is an important feature for traders participating in dynamic markets with high volatility and strong swings.

Calculating the Exponential Moving Average

■ EMA = Current Price * T + EMA Yesterday * ( 1 - T )

Where T= 2 / ( Number of Periods + 1 )

 

(3) Weighted Moving Average (WMA)

The Weighted Moving Average gives more weight to recent price data as in the case of the the Exponential Moving Average.

Calculating the Weighted Moving Average

■ WMA = SUM ( Closing Price * Sum of Weight Coefficients in a number of periods ) / SUM ( Sum of Weight Coefficients in a number of periods)

 

(4) Smoothed Moving Average (SMMA)

In order to calculate the Smoothed Moving average we must first calculate the Simple Moving Average (SMA1).

Calculating the Smoothed Moving Average

■ SMA1 = SUM of closing prices / number of periods

The main SMMA is calculated as:

■ SMMA = { SUM (T) – SMA1 + Closing Price } / T

Where:

SUM(T) – equals the sum of all closing prices for T periods
SMA1 – is the simple moving average calculated before
Closing Price – the last closing price
T – is the number of periods

 

(5) Triangular Moving Average (TMA)

The Triangular Moving Average is based solely on the simple moving average.

Calculating the Triangular Moving Average

■ TMA = SUM (SMA values) / T

Where:

SMA values are the values of the simple moving average for a number of periods

T is number of periods.

 

(6) Moving Average Envelopes

Moving average envelopes is the combination of two moving averages forming a visual channel. This channel highlights the historic overbought and oversold levels. The formation of the moving average envelope can be deployed using any different any type of moving average.

Calculating the Moving Average Envelopes:

■ Upper Band = SMA (T) * [ 1 + ( P (%) ) ]

■ Lower Band = SMA (T) * [ 1 – ( P (%) ) ]

SMA (T) = It is the Simple Moving Average of T periods
P = It represents a percentage (%). Based on the value of P, the two moving averages will form a channel with a distance of 2P. The P should represent the historic volatility of an asset. The value of P should increase in High-Volatility assets and decrease in Less Volatility assets. Most commonly you may use the value P=1%.

Trading using Moving Average Crossovers

 

Trading Signals using Moving Averages

You may trade using the Moving Average Envelopes using these simple rules:

□ Buying Signal: When the current price reaches the Lower Band and take profit the Upper Band

□ Selling Signal: When the current price reaches the Upper Band and take profit the Lower Band

Note that you should confirm any signal produced by the Moving Average Envelopes using another indicator (for example %R Williams or RSI).

HotForex Analysis

 

A simple Trading Strategy using two Simple Moving Averages

Here are the steps of a simple strategy using 2 SMAs (Simple Moving Averages):

(i) Open MT4 and choose a currency in H1 timeframe

(ii) Insert two SMA

SMA-1 (fast): choose 10 periods

SMA-2 (slow): choose 21 periods

(iii) Insert the ADX indicator for confirmation

(iv) Trade using this rule:

-If the fast SMA (10 periods) crosses the slow SMA (21 periods) you get a Buy signal. Confirm this signal with a falling ADX

-If the slow SMA (21 periods) crosses the fast SMA (10 periods) you get a Sell signal. Confirm this signal with a rising ADX

 

 

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» Standard Deviation

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» Moving Averages » Fibonacci Trading
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What are the Moving Averages

George Protonotarios for WebForex.net (c)