Moving Average Indicator

Moving Average is one of the oldest forex technical indictors in existence, and its widespread popularity is mainly due to its simplicity and effectiveness. A moving average is basically the dynamic average of past market prices. It's dynamic in the sense that the moving average number will constantly change as time passes. A moving average indicator shows the general trend of the market. It is used to smooth out short-term spikes of price fluctuations. When the market is trading above the moving average, it is considered to be strong. When the market is trading below the moving average, it is considered to be weak. A good understanding of moving averages is essential to help you decide whether to enter or exit a trade.

There are three types of moving average: Simple, Weighted and Exponential.
Simple Moving Average - each data point in the specified period is given equal weight. The user needs to define whether the high, low or close is used, these data points are then added together and averaged.
Weighted Moving Average - gives more emphasis to the latest data. Each data point is multiplied by a weighting factor which will move every day. These figures are then added and divided by the total of the weighting factors. This provides smoothing to a curve of prices while being more responsive to the latest price movements.
Exponential Moving Average – Reduce the lag by applying more weight to recent prices relative to older prices. The method for calculating the exponential moving average is fairly complicated. The important thing to remember is that the exponential moving average puts more weight on recent prices.

Many traders however don’t know how to use moving averages correctly. The classic interpretation of a moving average is to use it in observing changes in prices. Investors typically buy when the price of an instrument rises above its moving average and sell when it falls below its moving average.

If using moving averages you need to understand that Moving averages are a lagging indicator NOT a leading indicator. They therefore should not be used on their own to initiate new trades. The fundamental error many traders make is to simply buy dips to the moving average and “hope” they hold.

Moving Averages are one of the most popular technical indicators used by traders charting the forex market. Moving averages are extremely important for not only isolating trends, support & resistance and momentum but more importantly, for highlighting the underlying bias of the dominant trading cycles. There are some issues with moving averages; most often critics cite the lack of sensitivity to the range of the markets because the average ignores the open, high and the low of each interval. This is especially evident in more volatile stocks which can be difficult to assess when neglecting the volatility of the instrument. Other factors such as breaking news also cannot be accounted for in any technical analysis. However the effectiveness of the moving average as an indicator is apparent by its sheer sustainability.