A simple moving average (SMA) is also called un-weighted mean of "n"data points. For example, a 20 day SMA of EUR/USD closing price is the mean of the previous 20 days EUR/USD closing prices. The formula is
being the latest closing price and the closing price 19 days ago.
In the calculation, each price point is given the same weight (1/20), hence the name un-weighted mean. Trends are easier to spot using a moving average than a candlestick price chart. This is because moving average smoothes the volatility inherent in price intervals (e.g. hourly, daily or weekly) and helps you to recognize trends. Putting in the same chart as price action, the moving average produces buy and sell signals to the analyst or trader. The longer the period, the smoother the moving average curves. In the chart above, 100 day MA is smoother than 50 day MA or 20 day MA. On the other hand, a longer period tends to overkill the volatility information. In the example, the 20 day MA filters out inherent volatility and shows the EUR/USD market big picture, while 100 day MA ignores the market downturn between Aug and Sep completely. The signals have a lag to market conditions, therefore a moving average is a trend following indicator. The 100 day MA only sees a upward trend at the end of September, 3.5 months after the rally starts.
SMA however faces two criticisms
1. It gives same weight to all data points, while the latest price points are more relevant and therefore should be given more weight.
2. It does not take all historical price point into calculation. These criticisms give rise of other moving average variations.
WEIGHTED MOVING AVERAGE (WMA)
In technical analysis, WMA is calculated as
This can address the criticism regarding weight. The latest price has the highest multiplier. The multiplier drops linearly to zero. Therefore no price point outside of the period is taking into the calculation. It still suffers from the second criticism.
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