The oldest and most commonly used of all forex indicators is the Moving Average. A moving average provides a modified view of price movement with smaller, less important price actions filtered out. It is designed to let the trader see the underlying trend of prices without being distracted by momentary spikes or chops which often occur. It is easy to understand and to calculate and can be interpreted in several different ways, which we will explore in later installments.
First, let’s talk about what a moving average is and how it is calculated. A moving average line is simply the average price value for some number of bars in the past, for instance if you create a moving average with a period of 10, that means that each point in the moving average trace is actually the average calculated from the 10 most recent price bars. The moving average (MA) is therefore a new version of the price line which has been filtered (smoothed) by combining the current bar price with the prices of the previous 9 bars. Since the MA value is based on the combined values of 10 bar values, it is said to have a period of 10. Any number of bars can be used as the period. Let’s look at a calculation example:
 Moving Average Example (Period = 4) |
This is an example of a 4 bar moving average (Period = 4). Because it uses data from 4 bars, the values for the first three bars cannot be calculated – there aren’t enough data points for the formula. The MA for Bar4 is calculated by adding Bar4 to the three previous bars, then dividing by the Period (4). This creates the average price value for the first four bars.
The MA for Bar5 is calculated in the same way, but in this case the value for Bar1 is left out (it’s too far in the past) and the value for Bar5 is included. We continue calculating each bar value in this way, creating a smoothed line which represents the movement of the price with much of the unstable action removed. There is also a delay in the price line that is introduced by the smoothing which can cause problems but can also be used to your advantage. We will discuss this more in a future installment.
The type of moving average chart indicator described here is the simplest type, and is usually called a Simple Moving Average (SMA). We will cover other, more advanced types in future articles.
[...] the previous post of this series I discussed what a Moving Average is and how it’s calculated. Now let’s get to the [...]