Moving Averages (MA for short) is a very basic indi
cator known by just
about every trader. If you haven’t heard of it by
now then you must really be
a newbie to trading. Because of it is so commonly
known I won’t go deep
into this subject, but will touch upon it for two r
easons. (1) To introduce it to
those who aren’t yet familiar with it, and (2) to e
xplain the basics of it as it is
the foundation of “S.E.X. Lines”, which is dealt wit
h in the next section.
Ok, the next few paragraphs are for those of you wh
o are new to trading to
understand what an SMA and EMA is. If you already
know about these then
just skip down a bit to get to the juicy part, or b
etter yet just read it as a little
refresher.
An SMA, which stands for “Simple Moving Averages” (so
me folks and
charting packages simply refer to this as MA or “Mo
ving Averages” as the
“Simple” is just implied) is a basic indicator your
charting package will
display over your charts. It draws a line showing
the average price over the
past x number of periods. Lets say you are looking
at a one hour chart (each
candle represents one hour) and you set your SMA to
“10”. What it’ll do then
is it will add the closing price of the previous 10
candles and then divide the
sum by the number of periods, in this case 10, to f
ind the average price from
the past 10 periods (ten hours in this example). T
his is a simple math
procedure you’ve learned to do in elementary school
. With each successive
period (new candle to the right) it redoes the comp
utation of calculating the
average of the past 10 periods by removing the last
candle (the now eleventh
candle to the left) and adding the newest candle’s
price into the average. It
keeps redoing this calculation for all the candles
displayed on your chart and
then plots the average prices onto your chart. Sinc
e the prices keep moving,
thus changing the average price, the line moves fol
lowing the current market
moves, hence why this is called a Moving Average.
The chart below has a
green line showing the 10 period SMA.
An EMA, which stands for “Exponential Moving Averag
e” is another basic
indicator your charting package will display over y
our charts. Like the SMA
described above it also creates a Moving Average pr
ice line on your charts
however the main difference is that the SMA compute
s a simple average
where each period is valued equally whereas the EMA
places more emphasis
on the more recent prices. As the more recent pric
es are valued more than the
older prices the “average” price tends to be closer
to the current market
price. The chart below has a purple line showing t
he 10 period EMA. What
is important to notice is that though both lines sh
ow the same moving average
period the purple one (EMA) is more responsive to t
he actual market
fluctuations, and you also see that it crosses over
the green line (SMA) after
the market changes directions
Some charting packages also have a WMA option. This
stands for “Weighted
Moving Average”. As explained in the previous para
graph discussing EMA,
the WMA places more emphasis on the more recent dat
a but the way it is
calculated is different. Feel free to experiment wi
th it if you want, but you’ll
find that all you’ll be working with are just the SM
A and EMA lines.
How are these lines used by traders? There are two
common ways (an
advanced method is exposed in the next section). M
ethod 1 is that traders pay
attention to when the market price crosses over a c
ertain period MA (usually
just one line on the chart). Method 2 is that trad
ers pay attention to when a
shorter period MA crosses a larger period MA (usual
ly two lines on the chart).
The chart above shows EUR/USD daily candle view. On
this chart I’ve put a
50 period SMA (the yellow line) and the 200 SMA (the
green line). This is to
illustrate “method 1”. Normally a trader would jus
t have one MA line (either
simple or exponential), but I’ve put two lines on t
his chart to contrast different
periods. Actually, what I just said is not complet
ely true. Traders often do
have multiple MA lines for this method simply to wa
tch when the market
penetrates through any of those lines.
With “method 1”, traders plot the MA lines on daily
charts (usually a SMA) to
watch when the market crosses the line. Common dai
ly periods observed by
many traders include 50, 100, and 200. Why these n
umbers? Well some
people may give you some nice sounding rational beh
ind these numbers but
truthfully they are just nice round arbitrary assig
nments; you could use weird
numbers like 47, 108, and 222 about as effectively.
Ok, I’ve heard arguments
that 50 and 200 statistically have performed with e
xcellent results to act as
significant resistance/support levels, and to some
extent would agree from
what I’ve observed though I didn’t conduct any stat
istical analysis myself.
A lot of trader’s resource websites make mention of
when the market crosses
these significant MA lines. Many traders consider
penetration of these MA
lines to be a significant event. Why? Well just l
ook at those lines on the chart
above. Notice that when market touches/crosses the
line that soon after the
market races off for quite some time (trending) bef
ore it eventually reconnects
with that same MA line.
There are many traders that ONLY trade based upon w
hen the market
connects with the MA line. This is such a simple i
ndicator, yet it is
sooooooooo very powerful, and if you were to only t
rade based upon this then
you would do quite well for yourself.
Earlier on I mentioned that there was another metho
d, “method 2”, of how
traders use these MA lines. This simply involves h
aving two MA lines (either
simple or exponential) an observing when the two li
nes cross. The chart
below shows EUR/USD hourly candles with a 5 period (
yellow) and 20 period
(green) SMA. The numbers 5 and 20 are commonly used
for this method on
various timeframes, but you can play around with ot
her combinations.
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