Moving Averages (Trend following indicator)
Moving averages are one of the most popular and easy to use tools available to technical analyst.This smoothens the data series and make it easier to spot trends.That is especially helpful in volaile markets.Simple moving averages(SMA).A simple moving average is formed by computing the average (mean) price of curencies over a specefied number of periods.Most of the moving averages are created by closing prices. Exponential Moving averages (EMA's).EMA's reduce the lag by applying more weight to recent prices relative to older prices.The important thing to remember is that EMA puts more weight on recent price.
Trend following Indicator.Moving averages smoothout a data series and make it easier to identify the direction of the trend.Moving averages will not predict a change in trend, but rahter follow behind the current trend.Therfore they are best suited for trend identification and trend following purposes not for prediction.
USES. Moving averages work well during trends, and is ineffective in trading ranges.Usually a simple visual assessment of the price chart can determine if curencies exibit characteristics of a trend.It is always under the price during uptrends and above the price during downtrends.The number of periods used in a moving average will vary according to the currencies volatility,trendiness and personal preferences. The more volatility there is the more smoothing that will be required and hence longer the moving average.Currencies that do not exibit strong characteristics of trend may also require longer moving averages.
Examine how the moving averages fits with the price data.If there are too many breaks, lengthier moving averages to be used to decrease its sensitivity.
EMA's are usually best for short term situations that require a responsive moving average.SMA's work well for longer term situations that do not require a lot of sensitivity.
Uses of MA
1) Trend identification and confirmation. 2)Support and resistance level identification and confirmation. 3)For making trading systems.
There are three ways to identify the trend 1) Direction of MA 2)Location of price 3) MA cross overs. eg. Moving average is rising then trend is considered up. If the price is above the moving average then trend is considered up.If the shorter MA is above longer MA then the trend is considered up. Reverse the above during downtrends.
Support and Resistance levels.
As with trend identification support and resistance level identification through moving averages work best in trending markets.Usually an assessment can be made with a visual examination of price chart but sometimes it will require a detailed approach.
Limitation.Lagging indicator.Will not indicate trend changes.however MA's will help ensure that a trader is in line with current trend.
Popular Moving averages. EMA's 200, 100, 50, 20, 10 and 55, 40, 52, 36, 34, 8 SMA's 200, 100, 50, 20, 10 and 55, 40, 52, 36, 20, 65
EMA's 200 and 40, 144 and 89, 100 and 30, 60 and 20. These combinations are used for system development.You can research and try out other cobinations also.