Role of Moving Averages in Fx Market

Role of Moving Averages in Fx Market

Submitted by adil on Wed, 12/31/2014 - 12:07

Moving averages are very useful in real-time situations when the market prices undergo unexpected fluctuations regularly. Combining this with other forms of technical analysis such as reading chart patterns will greatly enhance the chances of making guaranteed profits. To overcome the difficulties in performing precise analysis due to varied price movements, traders utilize moving averages to get a clearer picture of the market.

Types of moving averages:

There are many types and variations traders use for determining the moving averages. The most popular and commonly used types are:

Simple Moving Average (SMA): This is one of the simplest type of moving averages. Most of the traders use this for analysis purposes. Calculating SMA is very easy, sum the closing prices during the time period you are analysing and divide them by the number of closing prices occurred during the same interval. Consider an example of calculating SMA over a period of 10 days. There will be one closing price corresponding to each day, we will sum up the 10 values of closing prices and divide them by the 10. This will return a more streamlined output to the trader which will help him decipher the price trend and he will be able to make much better decisions.

Many expert traders who are now trading more on short term basis have the opinion that SMA is not sufficient to analyse the more recent trend in an accurate fashion. In SMA, all the data is given the same priority which in certain cases, ignores the fact that an outlier value will drastically change the outcome even when they are irrelevant to the current scenario. For traders who are interested in these situations, there are other advanced and rather complex methods to calculate moving averages.

Linear weighted Average (LWA): Where SMA lacks in providing accurate insights, traders deploy LWA to analyse the market situation precisely. In calculating LWA, more emphasis is put on recent closing price values through a weightage system. The subsequent results significantly help those traders who are more interested in latest market performance. It is easy to infer that in this method, the most recent price value will get the most priority and the most former will get least priority.

For example, if we take LWA for a period of three days, the closing price of oldest day will get multiplied by one, price of middle day will be multiplied by two and the closing price of most recent day will get multiplied by three, and the values summed up. The resulting value will be divided by the sum of multipliers, in this case it is

1+2+3 = 6.

Exponential Moving Averages (EMA): This is the most complex of the lot, not only to calculate but also to understand. Luckily EMA is usually provided by charting services so the trader doesn’t need to calculate on his own. For advanced traders, EMA is a treasured analysis tool.

Many traders still use SMA, EMA is important for traders who are trading short term because EMA is the fastest to adjust itself according to trend changes.