Moving Averages

Moving averages lay the basis for our study in technical analysis indicators. Moving averages are the most simplistic form of an indicator as they use the past prices of a currency pair to help traders see the future direction of a currency pair.

You probably already know what an average is. To calculate an average, we take all the numbers, add them up, and then divide by the number of data points in our calculation.

For example: The average of 1, 10, 14, and 15 is 10. We add all the numbers up (1+10+14+15= 40) then divide by 4, since we have four numbers to get an average of 10.

In a moving average, the average is calculated based on a certain number of periods. If we set a moving average for 20 periods, then the 20 previous prices for the currency pair will be averaged, and the average point is plotted on a chart. On the candlestick or bar, the 20 previous prices are added, divided, and plotted. From there, the moving average points are connected to make a really smooth line:

Moving averages serve two purposes:

1. Showing a trader how the currency pair’s average of recent prices stacks up against the current price.
2. Providing very critical information we need to trade a currency pair. Moving averages can act as trading signals, support and resistance, and generally provide information necessary to determine if a currency pair is soon rise, or fall.

We can adjust the moving average by:

1. Changing the number of “periods” used to make the calculation. Using more periods will make the moving average smoother, while using less will make it more volatile.
2. Changing the underlying calculation. Moving averages come in two types: simple and exponential.

In the upcoming chapter, we’ll explain both simple and exponential moving averages, and how you can use them to determine when to buy, sell, or hold a currency pair