One of the most simple and popular technical analysis indicators is the moving averages method. This method is known for its flexibility and user-friendliness. This method calculates the average price of the currency or stock over a period of time. The term “moving average” means that the average moves or follows a certain trend. The aim of this tool is to indicate to the trader if there is a beginning of any new trend or if there is a signal of end to the old trend. Traders use this method, as it is relatively easy to understand the direction of the trends with the help of moving averages.
Moving average method is supposed to be the simplest one, as it helps to understand the chart patterns in an easier way. Since the currency’s average price is considered, the price’s volatile movements are evened. This method rules out the daily fluctuation in the prices and helps the trader to go with the right trend, thus ensuring that the trader trades in his own good.
We come across different types of moving averages, which are based on the way these averages are computed. Still, the basis of interpretation of averages is similar across all the types. The computation of each type set itself different from other in terms of weightage it lays on the prices of the currencies. Current price trend is always given a higher weightage. The three basic types of moving averages are viz. simple, linear and exponential.
A simple moving average is the simplest way to calculate the moving price averages. The historical closing prices over certain time period are added. This sum is divided by the number of instances used in summation. For example, if the moving average is calculated for 15 days, the past 15 historical closing prices are summed up and then divided by 15. This method is effective when the number of prices considered is more, thus enabling the trader to understand the trend and its future direction more effectively.
A linear moving average is the less used one out of all. But it solves the problem of equal weightage. The difference between simple average and linear average method is the weightage that is provided to the position of the prices in the latter. Let’s consider the above example. In linear average method, the closing price on the 15th day is multiplied by 15, the 14th day closing price by 14 and so on till the 1st day closing price by 1. These results are totaled and then divided by 15.
The exponential moving average method shares some similarity with the linear moving average method. This method lays emphasis on the smoothing factor, there by weighing recent data with higher points than the previous data. This method is more receptive to any market news than the simple average method. Hence this makes exponential method more popular among traders.
Moving averages methods help to identify the correct trends and their respective levels of resistance.