Hello to all. We can say that the most profitable business
in the world is trading in financial markets, of course, if one is successful.
When trading in financial markets, encountering both gains and losses is
inherent to the nature of the market. Experienced traders manage to minimize
risks and develop their own unique trading strategies. In other words, everyone
should find their own unique approach to trading in the market. This is where
technical analysis comes to the forefront. In technical analysis, there are
different methods to predict price movements. One of these widely used methods
is technical indicators. Technical indicators do not behave emotionally unlike
humans, which is why they are preferred by many. In this article, we will focus
on the Moving Average indicator.
What is the Moving Average?
The Moving Average is one of the most preferred and widely
used technical analysis indicators in financial markets for determining trends.
Moving averages are favored by almost everyone who trades in the market due to
their simple and easily understandable structure. They are known as
trend-following indicators because they provide a guide as to where prices may
be heading in the market. Essentially, their purpose is to smooth out
fluctuations in a data series by calculating the average of data over a
specific period. This makes trends and patterns in the data more apparent and
sometimes reduces noise. Moving Averages can be used not only to identify
trends when analyzing price movements in financial markets but also to define
support and resistance levels and generate entry and exit signals.
Additionally, Moving Averages provide data for many other technical indicators
used in financial markets, such as MACD, RSI, PSAR, and Bollinger Bands.
Types of Moving Averages
We typically use Moving Averages to analyze price movements
in financial markets. In Forex and stock markets, you can encounter various
types of moving averages. The most commonly used and widely known main types of
moving averages include the following:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Weighted Moving Average (WMA)
Now, let's take these one by one.
Simple Moving Average (SMA)
SMA is a basic moving average obtained by calculating the
average of a financial asset's price movements over a specific period (e.g., 10
days, 20 days, 50 days, or 200 days). For example, a 10-day SMA calculates the
average of the closing prices for the past 10 days. This period represents the
data within a given time frame. SMA can be considered a statistical indicator
used in various financial analysis and time series data analysis contexts.
Calculation. The calculation of the Simple Moving
Average (SMA) is quite easy. The basic formula used to calculate SMA is as
follows:
SMA = (P1 + P2 + P3 + ... + Pn) / n
Here: SMA represents the Simple Moving Average. P1, P2, P3,
..., Pn represent each data point (e.g., closing prices) for a specific period.
"n" indicates the length of the period used. When each new data point
arrives, the oldest data point used in the SMA calculation period is
subtracted, and the new data point is added, thus continuously updating the
SMA. This allows the SMA to track changes in trends and movements within the
data series.
How to Trade. SMA
helps us see trends more easily by reducing the impact of small fluctuations in
the data series. If the SMA of a stock or another financial asset is gradually
rising, it indicates an uptrend. Conversely, if the SMA is declining, it
signals a downtrend. In addition, SMA can be used to identify support and resistance levels. If prices move near the SMA for a specific period, it can
function as a support and resistance level. If the short-term SMA crosses above
the long-term SMA from below, we enter a Buy order. Conversely, if it crosses
from above to below, we enter a Sell order. In the example below on the AUD/USD
chart, you can see Buy/Sell orders being triggered and identified
support/resistance levels when the short-term SMA (SMA 20) crosses the
long-term SMA (SMA 50):
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| Trading with short and long-term SMAs on AUD/USD chart |
In the chart above, the short-term SMA (SMA 20) is
represented by the blue line, while the long-term SMA (SMA 50) is represented
by the orange line. However, you can customize these colors through the
indicator settings if you prefer different colors. Additionally, you can adjust
the input settings of the indicator to change the short-term SMA to 5, 9, 10,
etc., and the long-term SMA to 100, 200, etc. In other words, you can set it to
fit your own strategy. As the periods of SMAs increase, they smooth out market
fluctuations, but they also exhibit lag in reflecting the current direction.
Exponential Moving Average (EMA)
EMA is a type of moving average that assigns weight to each
data point. EMA is different from SMA in terms of its calculation method. EMA
gives more weight to recent data, making it react faster. This allows it to
reflect recent price movements and data more quickly compared to SMA. EMA is
particularly preferred in short-term analyses and situations where there is a
need to detect trend changes more quickly.
Calculation. The initial value is determined. The
first EMA value typically starts with an SMA and is considered the first data
point. The formula used to calculate EMA is as follows:
EMA(t) = [K x (P(t) - EMA(t-1))] + EMA(t-1)
Here: EMA(t) represents the EMA at time "t." P(t)
represents the data at time "t" (e.g., closing price). EMA(t-1)
represents the EMA at time "t-1." K is a constant that determines the
smoothing factor of EMA and is usually calculated using the following formula:
K = 2 / (n + 1), where "n" represents the length of the EMA period.
How to Trade. Trading using EMA in financial markets
is similar to SMA. In other words, if the short-term EMA crosses above the
long-term EMA from below, it's a buy signal. Conversely, if the short-term EMA
crosses below the long-term EMA from above, it's a sell signal. Look at the
example in the EUR/CHF chart:
 |
| Trading with EMAs in the EUR/CHF chart |
Moreover, just like in SMA, if prices cross above the EMA
from below and the EMA is trending upward, it's considered a buy signal.
Conversely, if prices cross below the EMA from above, and the EMA is trending
downward, it's considered a sell signal. Meanwhile, the slope of the EMA is
important. If the EMA is trending upward and its slope is positive, it
indicates an uptrend and provides buying opportunities. If the EMA is trending
downward, and its slope is negative, it indicates a downtrend and offers
selling opportunities. EMA, by giving more weight to recent data, allows for
faster tracking of market movements and quick identification of trend changes.
However, this can also increase the risk of generating false signals.
Therefore, it's important to use EMA carefully.
Weighted Moving Average (WMA)
This is a type of average calculated by assigning different
weights to each data point. It is used to give different levels of importance
to data points within a specific period. In other words, WMA is an alternative
to other moving average types like Simple Moving Average (SMA) and Exponential
Moving Average (EMA). WMA is calculated by assigning different weights to each
data point, and these weights determine which data points within the period
should be given more importance.
Calculation. WMA calculation formula is as follows:
WMA(t) = (P1 x W1 + P2 x W2 + ... + Pn x Wn) / (W1 + W2 +
... + Wn)
Here: WMA(t) represents the Weighted Moving Average at time
't.' P1, P2, ..., Pn represent each data point (e.g., closing prices) within a
specific period. W1, W2, ..., Wn represent the weights assigned to each data
point.
How to Trade. Trading with WMA in financial markets
is similar to SMA. That is, if the short-term WMA crosses above the long-term
WMA from below, it's interpreted as a buy signal. Rather, if the short-term WMA
crosses below the long-term WMA from above, it's seen as a sell signal. The
slope of WMA is used to determine the direction of the trend. If WMA is
trending upward, and its slope is positive, it indicates an uptrend and is
considered a buy signal. Conversely, if WMA is trending downward, and its slope
is negative, it indicates a downtrend and is accepted as a sell signal.
Additionally, if prices cross above the WMA from below, and the WMA is trending
upward, it's a buy signal. Inversely, if prices cross below the WMA from above,
and the WMA is trending downward, it's a sell signal. Refer to the example in
the GBP/CHF chart below:
 |
| Trading with WMAs in the GBP/CHF chart |
WMA is a type of moving average that allows for different
weights to be assigned to data points over different periods. This enables
users to customize WMA to meet their analysis requirements and market
conditions. For instance, those who believe that recent price movements are
more critical can assign more weight to recent closing prices, resulting in a
more responsive WMA. On the other hand, those who want to give more importance
to older data can create a WMA with a longer-term perspective by assigning more
weight to older data.
Don't forget. To be successful in financial markets
like Forex, it's important to understand the limitations of indicators and
strategies and be willing to accept risks. When trading, we should not forget
that no single indicator or strategy will always provide correct results.
Markets are constantly changing, and every trade carries risks. As a result, we
need to have a good plan and execute our strategy in a disciplined way before
trading. Also, before investing, we should have knowledge of both technical and
fundamental analysis and gain experience through multiple practice sessions. Wishing
you profitable trades!