A moving average is a technical indicator which is used to take away some of the volatility of raw price action. This is achieved by calculating the average closing price over a set amount of periods. This process is repeated over subsequent periods, with the net result being a line that shadows the price action. Moving averages cannot be used to predict future price actions as they are a lagging indicator.

The most common use of a moving average is for quick visual identification of a trend.

Positive Actions, Golden Cross and Black Cross

For example, if an instrument is trading above a 100 period moving average, over a set period, then it can be said that the price action is positive.

If a trader now adds the 50 period moving average to the chart, a variety of scenarios can be created based on the interaction of the price action and both averages. If the shorter 50 period moving average crosses above the 100 period moving average then it is said to be bullish and is defined as a Golden Cross.

As moving averages are lagging indicators, the price action will almost certainly be above the 100 period average at the time the crossover occurs.

If the shorter 50 period moving average crosses below the 100 period moving average, then it is said to be bearish and is defined as a Black Cross. As moving averages are lagging indicators the price action will almost certainly be below the 100 period average at the time the cross over takes place.

A moving average can act as a leash that a dog walker will use to control his pet. As the dog gets over excited it will pull at the leash as it moves away from the owner. At the point where the leash tightens as the dog struggles to move too far away the walker pulls the dog back towards him.

Price action that trades away and becomes increasingly extended from the moving average is very much like the over excited dog. Whereas the moving average is the leash that brings the price action back to a place where it feels most comfortable.

If for example the price action is trending higher, extended from the 50 period and 100 period moving averages, there is a tendency for upward momentum to lose energy. Eventually either the price action trades back down to meet the average, or in a sideways fashion that allows the average to catch up with the price action.

TYPES OF MOVING AVERAGES

THE FINIOR CAPITAL METATRADER MT5 PLATFORM OFFERS A VARIETY OF FEATURES AND CHART STUDIES. THIS NOT ONLY INCLUDES THE STANDARD SIMPLE AVERAGE BUT ALSO OTHER MORE EXOTIC VERSIONS SUCH AS THE EXPONENTIAL, SMOOTHED AND LINEAR WEIGHTED AVERAGES.

Simple Moving Average:

The Simple Moving Average (SMA) uses a very straightforward method to calculate the average line. This calculation being the simple average calculated over X periods. For example the SMA for 20 periods of closing prices is just that. Take the closing price for the last consecutive periods, add them together and then divide by 20.

Exponential Moving Average

The Exponential Moving Average (EMA) is viewed by many traders and investors as being more reliable than a Simple Moving Average. However both average types are very popular. The benefits of using one average over the other though has yet to be proven.

The reason why EMA’s are deemed as being more reliable is because greater weight is given to more recent price data outputs. The more recent the data, the more relevant. The sum of weighting should always equal 100. An SMA on the other hand gives all values the same weighting.

SMA are deemed to have a problem which is referred to as ‘‘barking twice’’. This term is used when the SMA reacts at the start of the moving average period when a new data output is included in the equation, and once at the end when this same data output falls out of the equation.

An EMA slope can be recognized with greater ease. This is because the slope EMA should point up when the price closes above the average and down when the price closes below the average. This tendency usually follows the most recent price closely, which means that the EMA is much quicker to react when compared to an SMA and the nature of the price action.

Smoothed Moving Average

The Smoothed Moving Average (SMMA) similar to the EMA is a weighted average. It is also very similar to the SMA. The difference between the SMMA and the SMA is how it treats the oldest data output. With the SMA, the oldest data output is simply subtracted from the SMA calculation. However in the case of the SMMA the previous smoothed average value is subtracted.

Linear Moving Average

The Linear Weighted Moving Average (LWMA) gives higher weighting to more recent data outputs. A data output is obtained by multiplying the closing prices by the position occupied in the data set. The data output is then added together and then divided by the sum of the number of time periods.

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