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The moving average is one of the most basic and frequently used technical analysis tools. Moving averages are used by traders to find trends, verify new trends and spot trends about to change direction. There are three types of moving averages: Simple, Weighted and Exponential. In a 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. As each data point is included in the equation a line is formed and the oldest data point in the sample is dropped. A 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. The weighted moving average provides smoothing to a curve of prices while being more responsive to the latest price movements. An exponential moving average is another method of giving more emphasis to the latest data. A percentage of the current price is multiplied by the preceding period's average price. Fortunately, nearly all charting packages do all the calculations for you. Traders look to find the optimum moving average for a particular currency pair. This process involves testing the different types of moving averages and varying the time periods used to find a fit for the price data. Many traders use more than one different moving averages on each price chart. For example a trader could use a 5 period, 13 period and 60 period moving average on the same price chart. The trader will observe how the moving averages can be used collectively to provide confirmation for a trade. Larger moving averages (eg. the 60 period) can help the trader to find the long term trend, but lag behind the price and are slow to react to a changing trend. Smaller moving averages (eg. the 5 period) can help to spot short term trends and reversals, they follow the price trend pretty closely but provide less of a smoothing look than a longer period moving average. Traders often look for a moving average that has been a line of support or resistance historically. This line is then used to enter stops, profit targets and observe trend reversal opportunities. Many traders also observe the moving averages to cross over to verify a trade opportunity. Like any other technical indicator, moving averages work with a delay. The moving average line is just a forecast of what could occur in the future, not a guarantee of what will occur. There are more than one other more complex moving averages you could come across. - Double Exponential Moving Average (DEMA) - Triple Exponential Moving Average (TEMA) - Forecast Moving Average - Least Squares Moving Average - Modified Moving Average - Time Series Moving Average - Triangular Moving Average - Zero Lag Exponential Moving Average The best way to learn how these different moving averages react to price data is to open up a forex (or stock) trading demo account and test them out on a chart.
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