Moving Average
Moving average in forex trading is one of the most straightforward trading strategies that can be acquired by an individual, and it can be highly efficient and effective. In an effort to facilitate the identification of trends, support and resistance levels, and potential entry and exit points, moving averages can be of assistance to traders by smoothing out the price data. Moving average tools are available on all trading platforms and charting applications. These tools are classified into three categories: SMA (simple moving average), EMA (exponential moving average), WMA (weighted moving average), VWMA, and SMMA. This article will provide an explanation of the most effective moving averages for forex trading.
What Is the Moving Average?
Moving average in forex trading can have multiple meanings, but the simplest explanation is in its name: an average of price movements in a specific period of time. But if we want to expand it more and create an indicator to help us see the price fluctuations more smoothly, then we have to set some parameters for it. For example, we can ask for the average of daily candle closes for the last 9 days. As you can imagine, this will result in having 1 number only in our chart for the current day, but if we repeat this query for every single day that has passed, we have multiple numbers, and if we connect these dots one by one, we have a line, and that line is called the simple moving average (SMA) indicator. As the price moves forward, the indicator will move with it; thus, the MOVING average term is used.
Moving averages in general, are calculated as trend-following indicators, but based on the different types of settings and types that traders can define for them, they can change their response time as well, and the trend-following feature depends mainly on the time period you choose for them.
What Are the Settings for Moving Averages?
The parameters and inputs of each moving average indicator are unique and differ from one platform to another, depending on its type: EMA, SMA, WMA, VWMA, or SMMA.
But in the Meta Trader 5 (MT5), which is the most popular and most advanced trading volume in the world, you can choose 4 different types of moving averages, but there are 2 parameters that are common for all of them, and those are time period and calculation source for the candles (based on open, close, high, low, hl2, hlc3, ohlc4, ...). For the time period, you are able to enter any number you like and for the parameter as well, you can choose any one of the options available to you, but which one is the best moving average for forex trading?
What Is the Best Moving Average for Forex Trading?
The best moving average for forex trading can vary based on your trading strategy and the instrument you are planning to trade on. But this article will show you the best moving average settings for any trader, strategy, or instrument to start profiting.
SMA (Simple Moving Average):
The most fundamental moving average is the Simple Moving Average (SMA), which is calculated by averaging the prices of a group of variables over a specific period of time.
For instance, to calculate the SMA for a 10-candle period, you take the data from the last 10 candles and simply divide the sum by 10.
For example, in the 5-Candle period SMA, if first candle has a close of 150 , second one has 150.5, the 3rd one has 151, the 4th one has 151.5, and the 5th one has 152, then the SMA would be (150+150.5+151+151.5+152)=755 and then divide it by 5 (755/5)=151
EMA (Exponential Moving Average):
Exponential Moving Average (EMA) gives higher levels of importance to the latest price data to make it more responsive. For instance and just for comparison between SMA and EMA, in Figure 2, you can see the EMA of 60 and the SMA of 60
Fig. 2
Did you notice how EMA is closer to price than SMA? This implies that EMA reflects recent price movements more accurately. You can probably guess why this occurs. When trading, it is considerably more crucial to look at what traders are doing right now than what they were doing the last couple of days.
Weighted Moving Average (WMA):
In a weighted moving average, the recent data is given an even greater weight than the exponential moving average. Consequently, the recent market movements have a greater influence on the average than the old price data. This means that the oldest rate in the calculation is weighted 1; the next oldest value is weighted 2; the next oldest value is weighted 3; and so on, up to the most recent rate.
For example, in the WMA with 3 as its period, the first candle has the weight of 1 and the close price is 30, the second candle has the weight of 2 with the close price of 31, and the 3rd and last candle with the close price of 34 has the weight of 3.
So in summary, we have 1+2+3=6 instead of 3 in SMA, which means the 3-candle WMA would be (30x1)+(31x2)+(34x3)=194, and the average is 194/6=32.33 . Compared to the 3-candle SMA, which will be 31.66, the importance of the latest candles is obvious.
In Figure 3, you’ll have a comparison between EMA and WMA as well.
Fig. 3
Moving Average Trading Strategy
Bear in mind that moving averages do not anticipate the start or the end of a trend. They only assist traders in confirming trends, but this confirmation occurs only after the actual reversal has taken place. Whatever platform you are using, whenever you add a moving average indicator, there is a default setting for it. In the SMA, by default, the time period is 9, or in MT5, it's set to 20, and the source is on the candle’s close.
The disadvantage of utilizing WMA is that it may be fuzzier than a Simple Moving Average (SMA), making it more difficult to distinguish a true trend from a random fluctuation in prices, resulting in a false trade signal.
For this reason, it is advised that traders use two of the moving averages together for better market responses, like having one SMA and one WMA alongside one another.
How Moving Averages Are Used in Forex Trading:
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Trend Following
Forex traders can use moving averages to help with their swing trades as well; for example, if a trader has a long position, they can hold their positions as long as the price is above the 60 SMA, and once they see a close below the SMA, they can exit their swing trade.
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Support and Resistance
Another use case of moving averages can be their role as a dynamic support and resistance for price; for example, a 200 SMA can act as a strong support or resistance. Traders should use these indicators along with their other PRZ and support and resistance zones for more confirmation in the forex market.
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Crossovers
A popular crossover method is the Golden Cross and Death Cross, which combine two moving averages, one with a shorter period and one with an extended period of time. A bullish trend is represented by the Golden Cross, which is the crossing of the short-term moving average over the long-term moving average. The interpretation of a cross below, also known as a death cross, is typically bearish.
