Forex Walkthrough

AAA

Charts - Moving Average Flavors

While most moving averages (MAs) take the closing prices of a given asset and factor them into the calculation, this does not always need to be the case. It is possible to calculate a moving average by using the open, close, high, low or even the median. Even though there is little difference between these calculations when plotted on a chart, the slight difference could still impact your analysis.

Finding Appropriate Time Periods
Because most MAs represent the average of all the applicable daily prices, it should be noted that the time frame does not always need to be in days. Moving averages can also be calculated using minutes, hours, weeks, months, quarters, years etc. Why would a forex day trader care about how a 50-day moving average will affect the price over the upcoming weeks? Rather, a day trader would want to pay attention to a 50-minute average to get an idea of the relative cost of the security compared to the past hour.

No Average Is Foolproof
As you know, nothing in the forex markets is guaranteed - especially when it comes to using technical indicators. If a currency pair bounced off the support of a major average every time it came close, we would all be rich. One of the major disadvantages of using moving averages is that they are relatively useless when an asset is trending sideways, compared to the times when a strong trend is present. As you can see in Figure 1, the price of an asset can pass through a moving average many times when the trend is moving sideways, making it difficult to decide how to trade.



Figure 1
Source: MetaStock



Responsiveness to Price Action
Traders who use moving averages in their trading will quickly admit that there is a battle between trying to make a moving average responsive to changes in trend while not allowing it to be so sensitive that it causes a trader to prematurely enter or exit a position. Because the quality of the transaction signals can vary drastically depending on the time periods used in the calculation, it is highly recommended that traders look at other technical indicators for confirmation of any move predicted by a moving average. (For more on various indicators, see Introduction To Technical Analysis.)

Beware of the Lag
Because moving averages are a lagging indicator, transaction signals will always occur after the price has moved enough in one direction to cause the moving average to respond. This lagging characteristic can often work against a trader and cause him or her to enter into a position at the least opportune time. One major problem that regularly arises is that the price may have already experienced a large increase before the transaction signal is emerges. As you can see in Figure 2, the large price gap creates a buy signal in late August, but this signal is too late because the price has already moved up by more than 25% over the past 12 days and is becoming exhausted. In this case, the lagging aspect of a moving average would work against the trader and likely result in a losing trade.



Figure 2
Source: MetaStock



Moving Average Convergence Divergence (MACD)
One of the most popular technical indicators, the moving average convergence divergence (MACD), is used by traders to monitor the relationship between two moving averages. It is generally calculated by subtracting a 26-day exponential moving average from a 12-day EMA. When the MACD has a positive value, the short-term average is located above the long-term average. This stacking order of the averages is an indication of upward momentum. A negative value occurs when the short-term average is below the long-term average - a sign that the current momentum is in the downward direction. Many traders will also watch for a move above or below the zero line because this signals the position where the two averages are equal (crossover strategy applies here). A move above zero is used as a buy sign, while a cross below zero can be used as a sell signal. (For more on this, read Moving Average Convergence Divergence - Part 1 and Part 2.)

Signal/Trigger Line
Moving averages can be created for any form of data that changes frequently. It is possible to take a moving average of a technical indicator such as the MACD. For example, a nine-period EMA of the MACD values is added to the chart in Figure 1 in an attempt to form transaction signals. As you can see, buy signals are generated when the value of the indicator crosses above the signal line (dotted line), while short signals are generated from a cross below the signal line. It is important to note that regardless of the indicator being used, a move beyond a signal line is interpreted in the same manner; the only thing that varies is the number of time periods used to create it.




Figure 3
Source: MetaStock



Bollinger Band®
A Bollinger Band® technical indicator looks similar to the moving average envelope, but differs in how the outer bands are created. The bands of this indicator are generally placed two standard deviations away from a simple moving average. In general, a move toward the upper band can often suggest that the asset is becoming overbought, while a move close to the lower band can suggest the asset is becoming oversold. The tightening of the bands is often used by traders as an early indication that overall volatility is about to increase and that a trader may want to wait for a sharp price move. (For further reading, check out The Basics Of Bollinger Bands® and our Technical Analysis tutorial.)



Figure 4



Now let's take a look at some more advanced technical indicators.
The Bearish Diamond


Related Articles
  1. Active Trading

    Moving Averages: Different Flavors

    By Casey Murphy, Senior Analyst ChartAdvisor.com Most of the methods in which moving averages are used in trading have been addressed within this tutorial, but this tool has also been used in ...
  2. Active Trading

    Moving Averages: Factors To Consider

    By Casey Murphy, Senior Analyst ChartAdvisor.com Data Used in Calculation Most moving averages take the closing prices of a given asset and factor them into the calculation. We thought it would ...
  3. Trading Strategies

    Technical Analysis: Moving Averages

    By Cory Janssen, Chad Langager and Casey MurphyMost chart patterns show a lot of variation in price movement. This can make it difficult for traders to get an idea of a security's overall trend. ...
  4. Active Trading

    Moving Averages: Strategies

    By Casey Murphy, Senior Analyst ChartAdvisor.com Different investors use moving averages for different reasons. Some use them as their primary analytical tool, while others simply use them as ...
  5. Active Trading

    Moving Averages: How To Use Them

    By Casey Murphy, Senior Analyst ChartAdvisor.com Some of the primary functions of a moving average are to identify trends and reversals, measure the strength of an asset's momentum and determine ...
  6. Active Trading

    Moving Averages: What Are They?

    By Casey Murphy, Senior Analyst ChartAdvisor.com Among the most popular technical indicators, moving averages are used to gauge the direction of the current trend. Every type of moving average ...
  7. Technical Indicators

    Use Moving Averages to Buy Stocks

    A moving average constantly updates a stock's average price, but it cannot predict a stock's performance.
  8. Technical Indicators

    The Four Most Commonly-Used Indicators In Trend Trading

    Here are the top indicators and tools trend traders use to establish when trends exist and to find entry/exit points.
  9. Chart Advisor

    Two Stocks Getting Ready To Move Lower

    Will today's bearish crossover between the 50-day moving average and the 200-day moving average signal the start of a long-term downtrend?
  10. Technical Indicators

    The Top Technical Indicators For Commodities Investing

    Traders can use "the usual suspects" (standard indicators for trend trading) when it comes to choosing indicators for investing in commodities. Here's how.
RELATED TERMS
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following ...
  2. Simple Moving Average - SMA

    A simple, or arithmetic, moving average that is calculated by ...
  3. Signal Line

    A moving average plotted alongside a technical indicator and ...
  4. Ease Of Movement

    A technical momentum indicator that is used to illustrate the ...
  5. Bollinger Band®

    A band plotted two standard deviations away from a simple moving ...
  6. Trigger Line

    A moving-average line found in the moving average convergence ...
RELATED FAQS
  1. Why is the Moving Average Convergence Divergence (MACD) important for traders and ...

    Take a look inside one of the most popular and widely trusted technical indicators, the moving average convergence divergence, ... Read Answer >>
  2. How can I use simple moving averages to signal when to buy or sell stocks?

    Learn about simple moving averages, simple moving average strategies and how to use these strategies to signal buy and sell ... Read Answer >>
  3. What is the difference between a simple moving average and an exponential moving ...

    The only difference between these two types of moving average is the sensitivity each one shows to changes in the data used ... Read Answer >>
  4. Why is the Exponential Moving Average (EMA) important for traders and analysts?

    Discover why chartists and technical analysts might use an exponential moving average (EMA) instead of a simple moving average ... Read Answer >>
  5. What do the bracketed numbers following a technical indicator mean?

    In technical analysis, it is common to see a series of numbers following a given technical indicator, usually in brackets. ... Read Answer >>
  6. How do I create a trading strategy with Bollinger Bands® and the MACD?

    Learn how to establish profitable trading strategies using technical trader favorites such as Bollinger Bands and the moving ... Read Answer >>
Hot Definitions
  1. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  2. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  3. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  4. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  5. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  6. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
Trading Center