What are moving averages?
No one can argue that moving averages are one of the most used technical indicators in forex trading. Moving averages help in lessening price fluctuations. In this way, there is a more apparent distinction between actual trend directions and the usual market noises. When we say moving averages, we mean taking the average of a currency pair’s closing price for the last “X” periods. If we look at a chart, the moving average looks like a snaky and curvy line “overlaid” or above the price. Japanese candlesticks represent the price.
We can call these types of technical indicators “chart overlay,” where the moving averages are overlaid on the price chart. Moving average, as an indicator, help us visualize what the future prices possibly look like. They work just like any other technical indicators.
Moving averages help smoothen price action and fluctuation.
Maybe it will cross your mind to just look at the price to see what you want to see. The only reason why we use moving averages is because of reality. And when we say reality, we mean that a trend will most likely not move in straight lines, so it is not enough to only look at the price. Price will always move up and down, and moving averages help flatten or smoothen out that zigzag to help traders see the actual trend. The slope of the moving average is an essential key in determining the trend’s direction.
There is more than one type of moving average, and every one of them has different intensities of smoothness. The smoother the moving averages, the slower the price movement reaction. The squigglier the moving average, the swifter its response to the price movement. If you want to smoothen out the moving averages more, here is what you can do: get the average of closing prices in a more prolonged time frame.
Choosing the moving average’s length
The way the moving average looks on the price chart varies depending on the length and the calculation. And when we say length, we refer to the number of reporting periods. The shorter the length, the fewer included data points in the calculation — the closer it is to the current price. The short length also means less use as there is less insight into the trend than the current price.
So, the longer the length, the more data points included in the calculation, which also means that there are lesser individual prices that affect the overall average. The more the data points, the smoother the price fluctuation, which makes us see the trends.
These two situations make it hard for us to recognize the actual price direction, so we need to select the proper length.
A little reminder
We’d love to remind you again that a moving average smoothens price data to make a trend following a technical indicator. They do not predict the future for us. They only define the direction.