A moving average (MA) is a type of technical indicator that is used to show the average value of a security's price over a specified time period. MAs are commonly used with time series data to smooth short-term price fluctuations and emphasize longer term trends. Appearing as curving lines overlaid on a price chart, moving averages are used to identify trends and define areas of possible support and resistance. Below, Figure 1 shows a EUR/USD chart with 20-period and 50-period MAs applied.
Figure 1: This EUR/USD chart has two moving averages: a 50-period, drawn as the dark blue line, and a 20-period, drawn in bright pink.
While there are many different types of MAs, the simple moving average (SMA) is the most basic. It is an unweighted arithmetic mean of the previous X number of price bars. MAs are typically based on the closing price of each price bar; however, traders can choose to base price on the open, high, low or other price. A SMA is calculated by adding the closing price (or other price) of the previous X price bars and dividing by X. For example, to find a five-period MA, we would add the previous five data points (prices) and divide by five:
Closing Prices: 5, 6, 7, 8, 9, 10, 11, 12, 13 and 14
First value of five-day SMA = (5 + 6 + 7 + 8 + 9) / 5 = 7 (35 ÷ 5 =7)
Second value of five-day SMA = (6 + 7 + 8 + 9 + 10) / 5 = 8 (40 ÷ 5 = 8)
Third value of five-day SMA = (7 + 8 + 9 + 10 + 11) / 5 = 9 (45 ÷ 5 = 9)
Each value is calculated using the previous five prices; as its name implies, a MA is an average that moves. Old data is dropped as new data becomes available, and the MA continues to print as new price bars form (a five-period MA, for example, always uses only five price bars in its calculation, even as more price data becomes available).
Many other MAs are used by technical analysts including the exponential moving average (EMA), double exponential moving average (DEMA) and MA crossovers, where two MAs of different lengths are added to one price chart.
MA Lengths and Timeframes
Investors and traders can customize a MA to suit individual analytical objectives. Short MAs, for example, are often preferred by short-term traders. These MAs may have a lookback period (the number of price bars to be used in the calculation) between five and 30. Traders who look for medium-term trends may use a lookback period that ranges between 20 and 60 periods. Long-term investors may focus on larger MAs with lookback periods of 100 or more.
In general, shorter MAs react faster to price and, as a result, tend to have less lag. Longer MAs, on the other hand, are less sensitive to price and do a better job at smoothing the price data. It is up to each trader to determine the MA length(s) that best suits his or her needs and preferences.
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