Simple Moving Average
A Simple Moving Average (SMA) is the average price for a specific time period. Here, average refers to the arithmetic mean. For example, the 20-day moving average is the average (mean) of the closing prices during the previous 20 days.
Why use the SMA?
The purpose of the SMA is to smooth out price movements in order to better identify the trend. Note that the SMA is a lagging indicator, it incorporates prices from the past and provides a signal after the trend begins. The longer the time period of the SMA, the greater the smoothing, and the slower the reaction to changes in the market. This is why the SMA is not the best Forex indicator for receiving advanced warning of a move.
But here’s a good aspect – it is one of the best Forex trend indicators when it comes to confirming a trend. The indicator usually operates with averages calculated from more than one data set – one (or more)within a shorter time period and one within a longer time period. Typical values for the shorter SMA might be 10, 15, or 20 days. Typical values for the longer SMA might be 50, 100, or 200 days.
You might be wondering – when does it signal a trend?
It signals a new trend when the long-term average crosses over the short-term average. If the long-term average is moving above the short-term average, this may signal the beginning of an uptrend. If the long-term average is moving below the short-term average, this may signal the beginning of a downtrend. You can experiment with different period lengths to find out what works best for you.
Exponential Moving Average
While similar to the simple moving average, this Forex trading indicator focuses on more recent prices. This means that the Exponential Moving Average (EMA) will respond quickly to price changes. Typical values for long-term averages might be 50-day and 200-day EMAs. 12-day and 26-day EMAs are popular for short-term averages.
A very simple system using a dual moving average is to trade each time the two moving averages cross. You then buy when the shorter moving average (MA) crosses above the slower MA, and you sell when the shorter MA crosses below the slower MA. With this system, you will always have a position, either long or short for the currency pair being traded.
You then exit your trade when the shorter MA crosses the longer MA. The next step is to place a new trade in the opposite direction to the one you have just exited. By doing this, you are effectively squaring and reversing. If you don’t want to be in the market all the time, this is not going to be the best Forex indicator combination.
In that case, a combination using a third time period might suit you better. A triple moving average strategy uses the third MA. The longest time frame acts as a trend filter. When the shortest MA crosses the middle one, you do not always place the trade. The filter says that you can only place long trades when both shorter MAs are above the longest MA. You can only go short when both are below the longest MA.
Moving Average Convergence/Divergence (MACD) is a Forex indicator designed to gauge momentum. Not only does it identify a trend, it also attempts to measure the strength of the trend. In terms of giving you a feeling for the strength behind the move, it is perhaps the best indicator for Forex. Calculating the divergence between a faster EMA and a slower EMA is a key concept behind the indicator. The indicator plots two lines on the price chart.
The MACD line is typically calculated by subtracting the 26-day EMA from the 12-day EMA, and then a 9-day EMA of the MACD is plotted as a signal line. When the MACD line crosses below the signal line, it is a sell signal. When it crosses above the signal line, it is a buy signal. You can set all three parameters (26, 12 and 9) as you wish. As with moving averages, experimentation will help you to find the optimal settings that work for you.
Also read: Best Technical Indicators for Forex traders – Part 1
