Moving Averages

Moving Averages are probably the most commonly used technical indicators due to their simplicity and versatility. Moving Averages (M.A.'s) are simply an average of the closing prices for a specified number of time periods. The average is represented by a continuous line plotted on a chart showing price action. There are two types of Moving Averages: Simple and Exponential.

Simple

Simple Moving Averages are an arithmetic average of the closing price of a specified time frame. Simple Moving Averages (SMA's) are slow to respond to a trend change, but are less subject to whipsaw. "Whipsaw" refers to situations in which the market fluctuates drastically and does not indicate a definite trend. SMA's are better able to gauge an overall trend of the market and are generally not useful in identifying a new emerging trend. SMA's are ideal for showing the overall sentiment of the market, instead of just the current. This allows traders to see a broader view and make a general prediction of future price.

Consider the following EUR/USD prices:

1.2700   1.2710   1.2720   1.2730   1.2740
1.2750   1.2760   1.2770   1.2780   1.2790

The 10 period Simple Moving Average will be 1.2745; the average of the previous 10 price bars.

Exponential

An Exponential Moving Average (EMA) is a moving average with the most recent price periods more heavily weighted, therefore giving more emphasis to what is currently happening in the market. This allows for early detection of potential price changes, but can lead to false signals or whipsaws. EMA's are useful in identifying emerging trends; however, they tend not to identify existing trends very effectively.

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