By Forex Mansion
Technical analysis is a necessary part of being a solid Forex trader, one must be able to analyze and evaluate currency trading charts well. One of the first ways to understand looking at currency trading charts is through a comprehension of moving averages. These averages make a line through the medium price in a certain time frame to make the price changes a more even line. This leveling of price data directly translates to a trend following indicator.
Although this indicator is an excellent way to understand the current direction of a specific currency, what moving averages do not attempt to do is make any predictions. The purpose of this indicator is to base data analysis on past prices (known as the “lag”) in efforts to negate the effects of “chance occurrences” and noisy data outliers. Finally, this chart is known as being the base from which other technical indicators take life and become possible. Among the other indicators that rely on the moving averages charts are:
• McClellan Oscillator
• MACD
• Bollinger Bands
Moving average indicators are broken down into two separate types: Simple Moving Average and Exponential Moving Average. Both of these indicators attempt to shows the course and track of trends and related resistance levels. An excellent graph example with explanation can be found at the Street Authority site.
1. Simple Moving Average. This average indicator is, as its name, fairly easy to understand. By looking at a specific period or periods of time, this indicator shows the average price of a certain currency. Simply put, a 10-day SMA is the average of the closing prices for each of those 10 days. The key to this indicator is that with each new closing price, the least recent closing price is dropped from being included in the data, thereby showing the updated average price of a specific currency. The following shows the 10-day SMA formula:
• Daily Closing prices: 2,3,4,5,6,7,8,9,10,11,12,13,14
• Day 1 of SMA: (2+3+4+5+6+7+8+9+10+11)/10 = 6.5
• Day 2 of SMA: (3+4+5+6+7+8+9+10+11+12)/10 = 7.5
• Day 3 of SMA: (4+5+6+7+8+9+10+11+12+13)/10 = 8.5
The intention is not to give a snapshot of where the currency price might be heading, but rather where the currency is now in relation to a specific historical time frame.
2. Exponential Moving Average. This moving average takes the base of the SMA and tries to negate the effects of the “lag” of historical prices for the currency and gives more value to recent prices. After calculating the SMA, which will serve as the previous period’s first EMA. Then, the weighing multiplier had to be calculated, and finally, the actually EMA is calculated. The following example is for calculating a 5-day EMA.
• SMA is calculated
• Multiplier is calculated by dividing the time period (5) plus 1 in half:
(2/5+1) = .3333
• EMA is calculated: (Closing Price – Previous Day EMA) x Multiplier + Previous Day EMA
The intention is to give an accurate weighting to the most recent price, which is why the weighting for a shorter period will be greater than a longer period. The more figures included in each trend, the less important each specific closing price is to understanding the day trading data trending.
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