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What Are Moving Averages? Use Moving Averages to Find the Trend, Dynamic Resistance and Support Levels

What Are Moving Averages? Use Moving Averages to Find the Trend, Dynamic Resistance and Support Levels

When you are trading in the market, moving averages is one of the major technical indicators of what is to come and what you can expect from the market. The market and its trend reversals are always mixed with noise which can confuse you and lead to a loss. Moving averages differentiates the noise from the real trends so that it can help you make decisions in a more precise manner and take the maximum advantage of the market positions.

Moving average is the average of the closing price of one of the currency pairs for a specified period. This, when plotted on a graph, gives you a clear indication of what is to be expected from the market. The slope of this graph can help you determine the potential direction of the market with more accuracy before you decide to invest in the pair. The price action is smoothed out by moving averages which gives you a better look at the real trends. If the moving average is smoother, it will most likely not react much to the price movement. On the other hand, a quicker reaction to the price movement can be observed with a choppier moving average. The longer the period of your moving average, the smoother it tends to get. It is also useful to optimize the period considering the pair to ensure that there aren’t too many data points in the moving average to too less which can hamper the graph itself.

Simple Moving Average Explained

Simple Moving Average ExplainedIn the market of forex trading, simple moving average is the simplest of moving average. It helps you understand the trend based on the past closing prices of the currency pair. Simple Moving Average can be calculated based on taking a specific period of time and the closing prices of the pair during the period. Then add up the closing prices and divide by the number of data points that were added to get the simple moving average.

Let’s take an example here to understand how to calculate the Simple Moving Average. Let us consider a time period of five days. Take the closing prices for the past five days. Let them be 65, 66, 67, 66, 65. Now add them up. It gives you 329. Divide this by the time period which we considered as five days. Thus, we get a Simple Moving Average of 65.8. The longer time period you take for the Simple Moving Average, the smoother it is, thus helping predict the trend with more accuracy and ensuring that your money does 't turn up in a loss. But what you should consider is that the method is not a fool proof way of indicating the trend and hence you might carefully consider the odds before buying. Simple Moving Average is susceptible to spike which can change the reading and thus you must be careful of that. These are false signals, and a trend might not be picking up the pace. This can lead to losses as well.

Simple vs. Exponential Moving Averages

Moving averages is one of the most useful tools in understanding the trend reversal in the forex market. But people most often wonder which is better and more reliable. Let’s start with exponential moving averages first. Exponential Moving Average Short period EMA or exponential moving average is the best choice if you want a moving average that reacts to price movement quickly.

This will help you identify trends in its early days which can mean that you can ride them longer for higher profits. But the downside is that during consolidation, you can get faked out by the trends. This is because even a small amount of price movement can fake a trend. Simple Moving Average The exact opposite of Exponential moving average is a simple moving average where you should consider a more extended period of data points. The graphs are much smoother here since they are based on more extended time periods. They can give you an overview of the trend, and the chances of getting faked here are lesser too. The effect of the price movement is low here since the numerous data points available. But the downside is that you can miss out on a great deal altogether while waiting to accumulate enough data.

Which is better?

This part is for you to choose based on how high your risk tolerance is as well as which one suits you better. If you are looking to make a deal for a longer period, a SMA would be better but if it is the quick buck you are after, try the EMA.

Use Moving Averages to Find the Trend

Use Moving Averages to Find the TrendDetermining the trend of the currency pair is the best way to use moving averages in the forex market. The way to go is to plot a graph of the moving average taking a period of your choice and one that suits the type of deal you are looking for. If the price of the currency pair tends to stay above the moving average, the trend seems to be upward. Similarly, if the price is on the lower side of the moving average, it indicates a downward trend.

But the main problem with moving average is that it is too simplistic which can, in turn, backfire due to sudden surges in prices. This is a fake movement. Here, due to some news that might have come out, the price increased but the downward trend of the pair continues and hence leads to a loss if you invest. What can help you avoid this is plot more than one graph for the averages using different time periods. This helps to identify fake movement which can, in turn, save you some money. The two graphs will have different moving averages which will give you two moving averages which can be then extrapolated to find a trend. The knowledge of trend lines, as well as this, can help you determine whether you should short a currency or go long with it. Using more and more moving averages can help you further to determine the trend accurately.

Use Moving Averages as Dynamic Resistance and Support Levels

Another way to use moving averages is to determine dynamic resistance and support level. The term dynamic is used because they are not your regular level of resistance or support which are horizontal at all times, but these levels change with every price movement. This constant change of the levels makes them harder to spot using traditional methods. Many forex traders look at moving averages to test the resistance and support levels to determine their course of action. Though not identical to the usual support and resistance lines, they resemble them quite closely. This means that you should not expect a bounce in price as soon as it touches the moving average. Sometimes it may go a bit beyond before it bounces back to your favor. Occasionally, the price may dip quite considerably beyond the moving average. What you can do in such situations is use two moving averages.

When such a situation arises, you can sell the trade in between the two moving averages to still make a good deal. This space between the two moving averages is considered as the zone by many traders. This zone can be viewed as a zone of support or a zone of resistance depending on the trend of the market at that moment. Since the moving averages are continually changing, you could leave them on the graph to find out the zone at any moment and make a decision about your next move.

Wrap UP

Moving averages of many types and they are widely used in the trading industry for their vast number of uses. The most often used types of moving averages are exponential and straightforward.

They are easy to calculate and tend to predict the trends with more accuracy. Simple moving averages are susceptible to spikes which can reduce the accuracy. Exponential moving averages, similarly, are based on the latest market prices which make them prone to disillusion by sentiment. The period of the moving average decides how smooth it is so simple moving averages are smoother than exponential and even more so with more extended period simple moving averages. The trends can be identified faster using an exponential moving average, but they can be less accurate, on the other hand, you might realize a trend later in simple moving averages, but they are safer. They are also used as dynamic resistance and support levels across the market.

One way to predict these are to plot multiple moving averages on the same graph. The zone between the two moving averages is where you can make most of your money even during choppier times. It is hard to determine which moving average to use and there is no right answer because the answer depends on your trading style. If your risk tolerance is higher, exponential moving average is the way to go. But if you don’t mind missing out on early trends and prefer to stay safe, simple moving average is the best for you.

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