Moving Averages

(MAs)

◙ Usage: Evaluating Trends / Forecasting Trend Reversals

◙ Trading: Spotting reversals at Moving Average Crossovers

◙ Combining: RSI, ADX, and other indicators

◙ Standard Settings: 10-period, 21-period, 30-period, 50-period, 200-period MAs

 

Introduction to Moving Averages

Moving Averages or else MAs constitute the most common tool of technical analysis. They are used to identify current trends and to forecast potential price reversals. The great advantage of an MA is its ability to eliminate the impact of ‘Market Noise’. The 'Market Noise' usually leads traders to false assumptions about the upcoming market conditions. If you compare the current price of a financial asset with the value of a moving average (for example a 50-day MA) you get in just a glance a clear picture regarding if that asset is trading in overbought or oversold levels.

Basic Features of Trading with Moving Averages

(1) The Moving Averages can eliminate the impact of Market Noise and produce smooth results

(2) An MA can analyze the trend of any financial market (Stocks, Forex, Indices, Bonds, Commodities) in any timeframe (intraday, daily, weekly, monthly)

(3) Can signal trades and confirm the results of other technical analysis tools (ADX, RSI etc)

(4) Moving averages can be sub-components of a technical analysis system, or to be used as components of an automated trading system (EA)

 

Calculating the Main Types of Moving Averages

There are a lot of different moving averages that can be used:

(1) Simple Moving Average (SMA)

The simple moving average or SMA is one of the most popular moving averages.

Calculating the Simple Moving Average

The SMA can be easily calculated and it is actually showing the average price of a financial asset during a certain period.

■ SMA = SUM of closing prices/number of periods

Example: If an asset for the past 3 days has the following closing prices:

1^st day: $100

2^nd day: $105

3^rd Day: $110

Then the Sum of Closing Prices is $315 and the SMA = $105

($315 / 3 days = $105)

(2) Exponential Moving Average (EMA)

Moving averages such as the Exponential Moving Averages (EMAs) are more sensitive to recent price data than the Simple Moving Average (SMA). That is an important feature for traders participating in dynamic markets with high volatility and strong swings.

Calculating the Exponential Moving Average

■ EMA = Current Price * T + EMA Yesterday * ( 1 - T )

Where T= 2 / ( Number of Periods + 1 )

(3) Weighted Moving Average (WMA)

The Weighted Moving Average gives more weight to recent price data as in the case of the Exponential Moving Average.

Calculating the Weighted Moving Average

■ WMA = SUM ( Closing Price * Sum of Weight Coefficients in a number of periods ) / SUM ( Sum of Weight Coefficients in a number of periods)

(4) Smoothed Moving Average (SMMA)

In order to calculate the Smoothed Moving average, we must first calculate the Simple Moving Average (SMA1).

Calculating the Smoothed Moving Average

■ SMA1 = SUM of closing prices/number of periods

The main SMMA is calculated as:

■ SMMA = { SUM (T) – SMA1 + Closing Price } / T

Where:

SUM(T) – equals the sum of all closing prices for T periods
SMA1 – is the simple moving average calculated before
Closing Price – the last closing price
T – is the number of periods

(5) Triangular Moving Average (TMA)

The Triangular Moving Average is based solely on the simple moving average.

Calculating the Triangular Moving Average

■ TMA = SUM (SMA values) / T

Where:

-SMA values are the values of the simple moving average for a number of periods

-T is the number of periods

(6) Moving Average Envelopes

Moving average envelopes is the combination of two moving averages forming a visual channel. This channel highlights the historic overbought and oversold levels. The formation of the moving average envelope can be deployed using any different any type of moving average.

Calculating the Moving Average Envelopes:

■ Upper Band = SMA (T) * [ 1 + ( P (%) ) ]

■ Lower Band = SMA (T) * [ 1 – ( P (%) ) ]

Where,

-SMA (T) = It is the Simple Moving Average of T periods
-P = It represents a percentage (%)

Based on the value of P, the two moving averages will form a channel with a distance of 2P. The P should represent the historical volatility of an asset. The value of P should increase in High-Volatility assets and decrease in Fewer Volatility assets. Most commonly you may use the value P=1%.

 

Trading Signals from Moving Average Crossovers

If some key moving averages cross over one another, the price trend may change soon. The crossovers of two key moving averages or the crossover of the price of an asset can be used as a trading signal.

Moving Average Crossovers

Moving averages can be used in pairs of a faster and a slower moving average. A crossover occurs when one of the two moving averages crosses the other.

■ Bullish crossover means that the faster-moving average crosses above the slower moving average

■ Bearish crossover means that the faster-moving average crosses below the slower moving average

Price crossovers

This situation occurs when the price of an asset crosses above or below a moving average.

■ Bullish crossover means that the current price crosses above the moving average

■ Bearish crossover means that the current price crosses below the moving average

Note that these signals are valid only if the slope of the price chart and the slope of the moving average are moving in the same direction.

Trading Signals using Moving Average Envelopes

You may trade using the Moving Average Envelopes using these simple rules:

■ Buying Signal: When the current price reaches the Lower Band and take profit the Upper Band

■ Selling Signal: When the current price reaches the Upper Band and take profit the Lower Band

Note that you should confirm any signal produced by the Moving Average Envelopes using another indicator (for example %R Williams or RSI).

 

Trading Strategy using 2 SMAs

Here are the steps of a simple strategy using 2 SMA (Simple Moving Averages):

(i) Open MT4 and choose a currency in H1 timeframe

(ii) Insert two SMA

SMA-1 (fast): choose 10 periods

SMA-2 (slow): choose 21 periods

(iii) Insert the ADX indicator for confirmation

(iv) Trade using this rule:

■ If the fast SMA (10 periods) crosses the slow SMA (21 periods) you get a Buy signal. Confirm this signal with a falling ADX

■ If the slow SMA (21 periods) crosses the fast SMA (10 periods) you get a Sell signal. Confirm this signal with a rising ADX

 

Platform Setup

You can install any Moving Average (MA) directly in MetaTrader-4 or MetaTrader-5:

□ GO TO → INDICATORS → TREND → MOVING AVERAGE

□ RECOMMENDED SETTINGS

→ FOREX TRADING: 34, 55, 89, 144, 233 PERIODS

→ EQUITY TRADING: 30, 200 PERIODS

 

■ Trading with Moving Averages

George Protonotarios for ExpertSignal.com (c)