Moving average is an indicator that shows the market fluctuations as a single curve. Moving average is an indicator to find the current trend of the market. This indicator can’t be used to see the future, but it can be used to illustrate the market’s current condition. It should be noted that this indicator shows the current market trend with a lag. The moving average is obtained based on previous prices. Therefore it comes with a latency.
Moving average is also used to develop other indicators. For example, it is used to obtain indicators such as Bolinger Bands and MACD. The moving average indicator has several types, but the simple moving average (SMA) and exponential moving ) are the most popular ones. Traders use the moving average indicator to determine the current trend and specify the support and resistance levels.
To add the moving average indicator in MetaTrader, you can use the below instructions.
Insert >> indicator >> trend >> Moving average
The simple moving average is obtained by calculating the price average over a certain period of time. The closing price is usually used to calculate the average. For example, if the moving average is selected for a 10 day period, it averages the closing price of the last 10 candles on the chart. As is obvious from the name of moving average, it moves each time a new candle is closed. While new candles close, the previous candles won’t be used anymore. Therefore the moving average indicator keeps moving as long as the market is active.
If the average is calculated using the exponential relation, the latency of this method will decrease. Recent candles have more weight in the average calculation in this method. The procedure to calculate EMA is different from SMA. Since all calculations are done via computer these days, there is no need to know the actual formulation of such calculation. You can add the moving average simply by several clicks in MetaTrader or Ctrader.
Although EMA and SMA are very different, this difference doesn’t mean superiority. EMA has lower latency, therefore it’s more sensitive to price variations. The EMA will change before SMA. On the other hand, SMA is more accurate in calculating the average. Therefore it can be used to specify support and resistance levels.
The performance of moving averages relies on the method and the chosen period. Therefore, if you want to use the moving average indicator, it is recommended to test different methods and time periods until you find the one that suits the symbol you are trading.
The time period and time frame for calculating the moving average varies with your trading strategy. In general, moving averages with 5 to 20 candles are used for short-term purposes. If you have mid-term purposes, you shall choose 20 to 60 candles to calculate the moving average. More than 100 candles are used for long-term purposes. Some time periods are more popular than others. For instance, traders usually use 200 moving average for long-term, 50 moving average for mid-term, and 10 moving average for short-time purposes.
Latency increases as the period of moving average calculation increases. For example, the 10 EMA has little difference from the actual prices and immediately changes as the prices change. To compare the performance of moving averages in different periods, boat and ship examples could be used. If the time period of indicators is short, the fluctuations of the indicator will be faster, just like small motorboats, which can easily change direction. On the other hand, if the chosen period is long, the variations will also be slower. Thus, long-term moving averages are like large ships that change direction slowly.
The signals generated from EMA and SMA are not technically different. They both generate signals on the same basis. Therefore, when discussing signals from moving averages, the type of the moving average is not mentioned. The application of all moving averages is the same. If the moving average trend is upwards, it means that prices are likely to increase gradually. Otherwise, it means that the prices are likely to decrease gradually. If the long-term moving average trend is upwards, prices are likely to increase in the long term.
Moving average indicators can be used to generate signals. John Morphy has mentioned such types of signals in his technical analysis book. Two types of indicators with different candle periods (such as 5 EMA and 35 EMA) are used for this purpose. In this method, a buying signal is generated when the short-time moving average passes above the long-term moving average. An inverse situation, a selling signal is generated.
Moving averages generate signals with latency because of their way of calculation. It doesn’t matter whether you change the period in which the average is calculated or not. Signals always will be generated with a latency. This latency increases proportionally with the length of chosen period for the moving average. But will this latency decrease with the length of the moving average period? The answer is yes, but the generated signals from such moving averages won’t be reliable because shortening the period of moving averages amplifies its fluctuations.
In addition to the double moving average method, three moving averages can be used to generate signals. In this method, when the short-term moving averages pass above the long-term moving average, a buying signal is generated. If the short-term moving averages pass below the long-term moving average, a selling signal will be generated. For instance, some traders use the 5,10, and 20-day moving averages.
One thing that shall be taken under consideration in the signal generating via moving average is the number of false signals. There is the possibility for false signals to form before the main one and cause traders to suffer loss. The MACD indicator could be used to filter the signals. The MACD indicator is made from two exponential moving averages. Therefore EMAs shall be used alongside this indicator. If a buying signal is generated via moving average, the MACD indicator shall enter the positive zone to validate this signal. To validate the selling signal, the MACD indicator shall enter the negative zone.
You can start generating signals based on the price chart and moving average. A buying signal is generated when the price passes above the moving average. In an inverse situation, a selling signal is generated. These signals can be used for long-term purposes. The long-term moving average shows the long-term trend of the market, and the short-term moving average shows the short-term trend of the market.
In this method, buying signals can be relied on only when the price is above the moving average. This means that buying signals are only valid when the long-term trend of the market is upwards. If the market’s long-term trend is upwards and a selling signal is generated above the moving average, it’s just a downward correction. But if the price passes below the moving average, it means that the trend is reversing.
You can use moving average to specify supports and resistances. For example, if the market is in an uptrend, it means that the price will be above moving averages. This means that the moving averages are the supports of the market.
If the market is in a downtrend, the price will be below the moving averages. In this case, the moving averages are the resistances of the market. Do not expect any sudden reactions when the price reaches the moving average. A fake break-in moving average is natural. Therefore consider moving average as the supporting or resisting zone instead of the exact location of support and resistance. For example, a 10 pip zone around a moving average is suitable for obtaining support and resistance.
Moving average is generally a trend-dependent indicator. Therefore it generates signals with a lag. This feature may seem unpleasant to most traders, but moving averages can be useful if you trade with trends. A moving average can convince you to trade with trends. Like most technical indicators, moving averages shouldn’t be used solely. Combining RSI indicator with moving average may generate better trading signals. Try to use moving average in addition to the indicator you already use. You will gradually find out about its applications after using moving averages for a while.
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