Moving average is a stock indicator used for statistical trends analysis. To achieve the said trends, you need to gather the trading activities such as movement of prices and trade volume. To achieve a constant price average, you need to calculate the moving average over a specific period.
There are different types of moving average. They are as follows bellow:
Simple/Arithmetic Moving Average
A simple moving average is obtained by adding the value of recent prices and dividing them by the number of the periods of recent prices.
A simple moving average is said to be customizable. This is because different numbers of periods can be calculated using the formula.
A simple moving average makes it easy to observe the price trends of securities by smoothening out the volatility. If the simple moving average points upwards, this means the prices are increasing, and if it points down, it means the prices are falling.
A short-term moving average is said to be volatile although its readings are closer to the source data.
Moving averages are significant tools used to analyze the most recent trends in prices and the potential for them to change.
A simple moving average is therefore used in technical analysis to determine if a security is in a gaining uptrend or a losing downtrend.
Simple moving averages can also be used in calculating and comparing different sets of simple moving averages of different time frames.
If a short-term average appears before or above a long-term moving average, then it is said the trend will or is expected to be an upward or increasing trend. If the long-term trend appears first above the short-term trend, then a down ward losing trend is said to be expected.
Popular Trading Patterns
There are two trading patterns that are said to use the simple moving average. They are:
- Death Cross
- Golden Cross
A death cross is a technical chart that shows you when to potentially sell off your securities.
It appears when the short term simple moving average, usually a fifty day simple moving average of stock cuts or crosses or appears below the long term moving average, usually a two hundred days simple moving average.
The death cross has proven to be a reliable method of predicting market trends especially in the severe bear markets of the past century.
The death cross is a very important long-term indicator because investors can use it to determine or lock gains before the next bear market begins.
A golden cross is where a short-term simple moving average appears or cuts above a long-term simple moving average. This indicates gains are in store for an investor. The golden cross is a bullish breakout pattern.
With the golden cross being a long-term indicator and carries more weight, it indicates a rising market trend in the near future and it forces traders to increase their trading volumes to make huge profits when the markets rise.
Simple Moving Average vs Exponential Moving Average
A simple moving average is the mean calculation of a set of prices of a specified period of past days, while Exponential Moving Average (EMA) refers to the average of prices in recent times used to give an idea of the current market prices.
The main difference between the simple moving average and the exponential moving average is in just how sensitive the values used in the calculations are.
Exponential moving average shows more weight in recent prices whereas the simple moving average shows equal weight in the prices.
Exponential moving averages are most reactive to recent or last price change than simple moving average since they place more weighting or recent data than they do on older data. This makes the pricing done using the exponential moving average more timely and hence is preferred by traders over simple moving averages.
Forex is not for the easily bored. To be able to trade successfully, you have to love numbers. The terms highlighted above are some of the most commonly used terms in trading forex. By understanding the terms used in the trade, you will be better placed to make informed trading decisions likely to influence your bottom line positively.