Thursday, 17 September 2009

Forex Indicators - Moving Averages

Most successful Forex retail traders use a variation of the moving average indicator. It’s one of the oldest technical indicators in existence, and its widespread popularity is mainly due to its simplicity and effectiveness.

What Is A Moving Average?

A moving average is basically the dynamic average of past market prices. It’s dynamic in the sense that the moving average number will constantly change as time passes.

How Does A Moving Average Work?

To give you a better sense of how moving averages work, here’s a simple example:

5, 7, 6

Above is a sequence of three numbers. The average of these three numbers is 6, right?

Now, let’s say that the next number in the sequence is revealed to us:

5, 7, 6, 2

Because we’re calculating the average of the latest three numbers, we have to drop the first number (i.e. 5), and use the more recent numbers 7, 6, 2 instead. The average is now 5. When the next number in the sequence becomes known, we will have to drop the earliest number of the three-number sequence (i.e. 7), and include the latest number to get a new average.

And this is basically how moving averages work, except that instead of random numbers we use historical market prices instead. You can of course specify the number of past prices to include in your moving average calculation. In a 20-day moving average for example, you would calculate the average based on the prices of the last twenty days.

What’s The Significance Of A Moving Average?

A moving average indicator shows the general trend of the market. It is used to smooth out short-term spikes of price fluctuations. When the market is trading above the moving average, it is considered to be strong. When the market is trading below the moving average, it is considered to be weak. A good understanding of moving averages is essential to help you decide whether to enter or exit a trade.

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