Moving averages or MA for short are one of the most simple of all indicators and they do exactly what their name would suggest. They are averages that move. "Average of what?" I hear you ask. Well it's an average of price data, so depending on what time frame your trading and how many units you have set it for will depend on the average it gives you.
For example if you are trading on an hourly chart and you have set your indicator for 12, then that would show you the average for 12 hours or half a day. The chart bellow is a hour chart with a 12-SMA.
One point to remember though, they are lagging. In other words they do not predict future direction they only provide an average from past price data. Past price data can be used to form the general trend of price, but price will always lead and the MA will always follow.
We are going to take a look at two types of here. The simple moving average, or SMA and the exponential moving average, or EMA.
The SMA is an average price of lets say a currency, over a specific number of periods. So a 10 day SMA is the 10 day sum of price divided by 10. Most moving averages are canculated using the closing price but you can choose the opening price or the high, the low and even a mix of them all! But you might just want to stay with the closing price for now.
The EMA tries to reduce the effects of lagging by applying more weight to the most recent price data. While the SMA as the name might suggest is simple math, the EMA is far from it, but fortunately for you most charting packages work it all out for you. PHEW!!! The EMA has less lag so it is more sensitive to recent price data and this will make it change direction before it's more simple brother the SMA.
Bellow is an example of the difference in how the SMA and EMA will look, note how the EMA (blue line) turns before the SMA.
Also bear in mind that the longer the MA is set the slower they are to show any direction change. For example the 200 day SMA will be very slow to change direction and will require sustained price movement to have an effect on it because of the amount of historical data. On the other hand a 10 day EMA will follow price much more closely turning soon after price and something like the 25-50 day will react some way in the middle.
See the chart bellow. See how the different moving averages react to changes in the price, note how the 200SMA (brown line)
does not change direction much.
There is a lot written about which settings are better and should you use SMA or EMA, but it really comes down to many different things such as your trading strategy/style, time frames and your own overall objectives. So you know what, when you find what works for you keep going with that.
A long term MA of 100 and more would be usefull for identifying trends in the market. If it was on the rise it would indicate that price is generally trending up and if it was falling it would indicate that price is generally trending down.
A short term MA of 10-50 is a good signal of the direction of price. Again if it was on the rise would indicate price is generally on the increase and if it was falling it would indicate that price is generally falling.
As well as using them to identify the trend and direction of the market it is also possible to use them to generate entry points for possible trades. Lets take a look at three possible ways to use them in this way.
MA cross over
Price Crossing MA
Support and resistance
Return for Moving Average to Using Indicators