How to Read and Use in Forex Trading
The forex market is one of the most traded markets globally. It is a complex form of exchanging one currency for another. It requires patience and the skill to discover profitable opportunities for making trades. These currencies get traded online, which means that the forex market has no actual location.
The trading of foreign currencies is not as complicated as it might initially seem. Some inexperienced traders tend to use almost half a dozen indicators for one trade. The most popular tool for technical analysis is the Simple Moving Average (SMA). The SMA got modified because of its lagging tendency. This modification produced the Exponential Moving Average (EMA). The EMA resists the lagging tendencies of the SMA by focusing more on recent data on prices.
Should to Use EMA or SMA?
The SMA and EMA share similarities as well as differences. They work hand in hand to analyze momentum and price trends in trading.
They are similar in that they are both used to test trends. Their results get interpreted in the same way. They are both also used for smoothing out price fluctuations by technical traders.
The main difference between the EMA and the SMA is the way they react to data changes used for calculations. The EMA focuses more on the current prices while the SMA calculates the average data prices. This means that the EMA focuses more on calculating the data of recent price changes.
The SMA calculates the data of all price changes, both old and new. The SMA is a common technical indicator that assists in determining the price of assets, especially over a specific time frame. It gets used to determine the direction of trends. It implements this by sorting out the data of past prices. It is pretty standard among traders in the financial market as it is used by either short or long-term investors and is considered a lagging indicator.
The EMA method of calculation has more impact on moving average than the SMA method. The SMA shows the average price value of an asset over a given time frame. This gets plotted as a line on the candlestick chart. The curve on the chart smooths out bumps on candlesticks. This provides visible clues on the market trends of a financial asset. When the curve is flat, the market is experiencing fluctuations. When the curve slopes, then there is a trend in the market.
Successful trading relies on studying various market trends. A trade position should get closed when a trend bends at the end. The SMA can be used for analyzing trends. Although it lags, it can also get used to close and open positions. This lagging can sometimes get unmoved by the volatility of the market.
The EMA got designed to resist the effects of the volatility of price and show the changing price trends. Most traders use an EMA and another EMA at different periods to get a signal in case of a price change.
The EMA also uses “price” and “period,” but it focuses on recent prices. It uses the prices to create an indicator that quickly responds to price changes. This fast response can also produce false signals. The EMA works best when it gets used with another EMA in a trending market.
The SMA (Simple Moving Average)
This is the most accessible type of average. It gets used more by technical analysts. It is quite common but flawed because all the calculated data prices have the same weight. Most traders believe that current data prices should have higher weights. And the weights should be higher than past data prices. Due to this flaw, most traders make use of the Exponential Moving Average.
The SMA is calculated by adding different past data prices and dividing it by the total of prices.
The EMA (Exponential Moving Average)
Unlike the SMA, the EMA focuses on the recent price data, and they react more to price fluctuations. This makes the result of EMA calculations more accurate. This is why the EMA gets preferred to the SMA by most traders. Short-term traders do not care about the average that gets used. This is because the difference between the two averages is usually a few cents.
Long-term traders pay attention to the average they use. This is because the difference is usually in dollars. This means that this price difference can influence returns primarily when a large amount of stock is being traded.
How is Moving Average Calculated in Forex?
Moving average in forex trading helps traders to make successful transactions. They do this by evaluating the price history of currency pairs. Moving averages make it easy for traders to analyze the fluctuations in the price of an asset. This gets done by smoothing out their movements.
Traders have analyzed a wide variety of indicators over time. But the moving average stands out because it is easy to use and practical. Using a moving average helps traders check price trends. It also allows traders to determine potential resistance and support levels of assets.
A moving average can also get called a lagging indicator. It assembles past prices and then looks for the average. This offers traders information about an asset over some time.
The moving average gets plotted as a price chart overlay. This makes it pretty easy to understand. There are two types of moving averages. These are the simple moving average and exponential moving average.
Calculating the Simple Moving Average (SMA)
There are various methods of calculating the Simple Moving Average. The SMA requires two details, the length and the source.
The length of an SMA is the number of intervals used in its calculation. The length depends on the types of trading strategies used. This may get designated in minutes, days, years, or even ticks.
The source, also called the source data, is the data taken from the past prices of assets. The source can be open, close, periodic, high, midpoint or low.
Many traders see the periodic close as the most relevant feature of price action. A valid data source gets determined by the type of trading strategy used.
In calculating the SMA, an asset’s closing price gets gathered. This gets done over different trading sessions.
For example, the 6-day moving average will get calculated by summing the six periods. Then the sum receives divided by the total number of periods given.
Here’s an instance,
When given the series of periods:
$11, $10, $15, $14, $12, $16
The calculation will be:
$11+$10+$15+$14+$12+$16 = $78
Total number of periods given = 6
The SMA calculation will be= $78 / 6 = 13
Calculating the Exponential Moving Average (SMA)
The EMA is more complex to calculate compared to the SMA. This indicator focuses on recent prices to avoid lagging.
A close observation of the SMA is essential in calculating the EMA. Assuming a trader wants to calculate a 30days observation for the EMA. The trader has to wait till the 30th day to have the SMA. On the 31st or 1st day of the new month, the trader can use the SMA gotten as the first EMA result.
The SMA calculation is simple. It is the sum of the asset’s closing prices at a specific period of time. This gets divided by the number of observations in that period.
The SMA for 20days will be the sum of closing prices for 20days divided by 20.
After calculating the SMA, the multiplier should get calculated for smoothing the EMA. The exponential moving average formula for calculating the multiplier is:
(2 ÷ (number of observations + 1)).
The multiplier for the 20days moving average will be:
(2 / (20 + 1)) = 0.952
The Exponential Moving Average Formula would be:
EMA = Closing price x multiplier + EMA (previous day) x (1 multiplier)
How to Read the EMA
The most used short-term averages are the 12- and the 26-day EMAs. They get used for generating indicators. Some of the indicators created are the Moving Average Convergence Divergence(MACD). And the Percentage Price Oscillator (PPO)
The 50- and 200-day EMAs are the indicators used for long-term trends. A reversal occurs when a stock price crosses a 200-day moving average.
Technical analysis is very useful for traders. Although the signals can sometimes lead to havoc when misinterpreted. The moving averages used for technical analysis are lagging indicators.
The EMA indicator is beneficial to traders due to its simplicity. Traders can analyze the price trend through the direction of the EMA. They should also be cautious as the EMA is equally a lagging indicator. It may not adjust immediately to rapid market volatility. However, the EMA responds faster than the SMA.
Using the EMA to Determine a Forex Strategy
One of the most used tools for forex trading is the EMA. Traders use it to determine the exit and entry points based on price action. The trader would consider placing a sell trade if it is high. He will place a buy trade if it is low.
There is a forex strategy that uses EMA. It relies on choosing a short and long-term EMA. Then trade gets placed based on the position of the short-term EMA against the long-term EMA.
A trader can use this strategy to place trades. He places a buy trade if the short-term EMA rises above that of the long-term EMA. A sell trade can get placed when the short-term EMA falls below that of the long-term EMA.
The number chosen signifies the time duration a trader decides when finding the EMA. For instance, if a trader wants to find the EMA for 10days, he chooses 10 EMA. This means that 10 EMA is the time duration of 10days.
How to Use the EMA Crossovers as Indicators to Buy/Sell?
A trader may decide to use a crossover of 30MA against a 10 EMA. That is, as a trading signal when using a trading strategy.
A trader may also decide to observe one EMA and how it affects price value. This is another strategy used by trading before making trade decisions.
The trader chooses the buy trade as long as the price value exceeds the selected EMA duration. When the price value remains below an EMA duration, it remains a sell trade. That is unless the price value rises above the chosen EMA duration.
Some of the popular EMA durations selected by traders are 5, 10, 30, 50, and 200. Short-term durations like the 5 and 10 EMAs get used for short-term trades. The long-term durations like 30 and 50 EMAs get used for long-term trades.
EMAs from 50 to 300 get used by traders for very long-term trades. The EMA indicator is very useful for traders. It helps determine the time to place a trade. It also helps the trader to make a decision on whether to make a buy or sell trade.
Drawbacks of the EMA
The EMA gets criticized for placing emphasis only on the recent prices. However, some traders believe that the current data reflects an asset’s trend better.
Other traders believe that finding the average of only recent prices creates bias, which might increase the rate of false alarms.
The EMA also relies more on historical data. Some technical analysts disagree as they believe that the market is very efficient. This means that the information needed to place a signal gets contained, especially at the current market prices.
Thus using historical data will not give a good signal on the direction of the price of an asset. That is, if the market is efficient indeed.
Uses of the EMA in Forex Trading
The EMA has many uses in the foreign exchange market. Some of the benefits of the EMA on the market include;
The EMA can be used to measure different trends, especially in its basic form. This means that a rise in the moving average shows a positive trend.
If the moving average falls, the market trend is negative or bearish.
The EMA can be used to show the resistance or support of a signal. This is because traders use some common EMAs. Most of them got used in stock trading in the past.
Some of the common EMAs are the 20, 50, 100, and 200 EMAs. Using these particular numbers can get considered psychological. And it gets regarded as a convention. Some traders even insist that some of these common EMAs work better than others.
The 9 EMA is common among short-term traders. This is because it reacts faster to price fluctuations than the 20EMA. Long-term traders still use the higher numbers. This is because the higher numbers use more information to create signals. And it uses the signal to determine the direction of the market trend. This keeps the trader present in an active trade for a longer time.
There is a notion that exists between professional traders. The idea that there is a perfect gold pot of indicators would end all trades with huge profits. That is, if it exists and when it gets found. The technical analysis gets given after an evaluation of past investments using indicators. It analyzes price patterns and trends to discover better trading opportunities.
The Exponential Moving Average is the modified form of the Simple moving average. The difference between the EMA and the SMA is the data used for calculating market trends.
The SMA calculates the average data of prices, both old and new. The EMA focuses more on the data of recent prices. It got designed to a large extent to resist the lagging of the SMA to price fluctuations.
The EMA is more preferred than the SMA to traders. This is because it is more technical and gives more accurate results. The EMA determines the movement of the market trend. It also provides a trader with a clear indicator of where to buy or sell.
Frequently Asked Questions
What is the best moving average to use in the forex market?
There is nothing like a best-moving average in the foreign exchange market. Although some moving averages that are used often. The exponential moving average is the most preferred moving average used among traders.
Especially the 9, 20, 50, 100, and 200 EMAs. These get used for either short-term or long-term trades. There are also other types of moving averages, but the result, in the end, remains the same.
What is the 50EMA?
50 EMA represents the moving averages of 50-days duration. It is also called the 50periods. The 50EMA is mainly used more by long-term traders.
It uses the closing price candlesticks for 50 days. It gets represented with a swirling line on the market chart. This line gets used to determine the movement of recent prices within a 50day period. The line goes up and down. That is, in an uptrend and a downtrend.