WHAT IS THE MOVING AVERAGE?

The financial market has various terms that are used frequently in the market. Traders keep referring to them but hardly know the terminology and its use.

The moving average is one such word traders come across daily. With the article, we'll be analysing the term and how it works to understand the price movements of the assets. So, let's have a brief look at moving averages.

Defining Moving Average

The moving average is a technical indicator or analysis tool. It combines the price points of an instrument within a time frame. Then the price is divided by the number of data points to get the result.

It gives a single trend line. The moving average is a popular trading analysis as it helps traders understand the current market trend. Besides, it also lessens the impact of random price spikes.

Traders can use it to determine the support and resistance level. The analysis uses previous data on asset movements in price. Thus, giving a prediction of its future changes.

Therefore, the moving average is a measure of change. The changes that trail from previous movements of the price of the asset. It assesses the history of the asset to determine possible future actions.

One can say that it is a lagging indicator. Nevertheless, it is the most used trading tool for technical analysis.

Why use Moving Average?

Traders use moving averages to frequently reduce the price chart noise. But, first, they analyse the direction of the moving average to get a basic idea of the price trend.

If the moving average is up, the asset's price moves upwards. But if the moving average angles downwards, the asset price moves down.

Also, the price is expected to be in a range.

In addition, it also acts as a support and resistance level. For example, in the uptrend, the 50 days, 100 days, or 200-day moving average acts as a support level. It is so because the average acts as a support.

A lso Read: Secrets of Forex Trading

Due to the support, the price bounces up off of the average price.

However, in a downtrend, the moving average may act as resistance. It is like a ceiling where the price hits the level and starts to drop again.

The price may not always respect the moving average. It may also move sideways; it may move slightly, stop or reverse before reaching the point.

The trend is upwards when the asset price is above the moving average. Conversely, the trend decreases if the price is below the moving average. Moreover, the moving average may have different lengths, so traders must check them correctly for correct decisions.

Considering the points traders can use easily, it is simple to understand on charts and helps make quick decisions.

Types of Moving Average

Moving average is mainly of two types; simple moving average and exponential moving average. Traders can use them to analyse the market trend and invest to earn profits.

Simple Moving Average

A simple moving average (SMA) is a way of calculating the moving average. The calculation takes the arithmetic mean of the set of values over a specific period. Traders can use SMA for five days, ten days, or more, depending on their requirements.

The simple moving average formula takes the assets' prices and adds them together. Then the total price of the asset is divided by the number of prices in the set.

The formula of Simple Moving Average is:

SMA = X1+ X2+ X3……….+ Xn/ n

Here, n = the number of the period

X = average in period n

Exponential Moving Average (EMA)

The exponential moving average gives importance to the recent prices. This is because the recent prices are used to make the data more responsive to the new information. To calculate EMA, traders take SMA over a specific time.

Then traders calculate the multiplier for weighting the EMA. It is known as the smoothing factor and uses the following formula:

2/(selected time period+1)

The formula for EMA is:

EMAt = [ V X (s/1+d)] + EMAy X [ 1- (s/ 1+d)]

Here,

V = Value

EMAt = EMA today

EMAy = EMA yesterday

S = Smoothing

D = number of days

Conclusion

The moving average is functional technical analysis. Traders can use it frequently to analyse market price changes and take corrective actions. It guides traders in analysing the market price, movements, and expected changes in the price.

The average takes the previous price of an asset to predict future price movements. Thus, an essential technical analysis terminology. The article briefly describes moving averages, why to use them, and the types.