The moving average (MA) is one the most popular technical analysis tools and for a good reason: it is both simple and effective. Traders use it alone or in combination with other indicators, as it is truly an irreplaceable tool for many.
How does it work?
In order to understand how to use the Moving Average, it is important to know how it works. A Moving Average is based on past performance and can be classified as a trend indicator. It measures the average price of an asset over a period of time.
Its main function is to reduce price noise and smooth out price movements. In fact, the general idea of the indicator can be expressed in four different types: Simple Moving Average (SMA), Weighted Moving Average (WMA), Exponential Moving Average (EMA), and Smoothed Simple Moving Average (SSMA).
The two most commonly used variants of moving averages are Simple Moving Averages and Exponential Moving Averages. When you find a strategy that involves the usage of a moving average, it will probably be one of these two. While SMA is a simple average of asset prices over a period of time, EMA focuses preferentially on more recent prices. The WMA also gives the most weight to the most recent candlesticks; the SSMA does not focus on a specific time period and is rarely used for trading.
How to use Moving Averages in trading?
Moving averages are quite a basic tool in technical analysis, but they have many practical uses in trading. Both professional and beginner traders like these indicators because of how easy they are for interpretation of signals.
One of the most common is to identify existing trends. By smoothing out price movements and reducing noise, moving averages allow traders to see the reality behind random price movements (known as price noise).
Moving averages can also be used as a dynamic support or resistance line. When the price hits a moving average from below, traders take it as a signal to sell the asset. When the asset price hits the moving average from above, it may be wise to consider buying the asset.
Example
Using a Simple Moving Average, let’s attempt to find entries on the Forex asset GBP/USD. The indicator smoothes the price movements and the crossovers of the chart and the SMA line are considered signals to buy and sell.
When the chart crosses the indicator from above with red candlesticks, it means that the price of the asset drops and the fall may continue. In this situation, traders may “Sell” the asset and ride the downtrend.
When the green candlesticks cross the indicator’s line from below, it means a trend reversal — the price starts growing and traders may enter a “Buying” position.
As you can see, the indicator is extremely easy in use, and, moreover, many of the more complex indicators such as Bollinger Bands, MACD, and McClellan Oscillator are based on moving averages.
Setting it up
To use this indicator for analysis on the IQ Option platform, you need to check the following steps:
- Click on the “Indicator” button in the lower left corner of the screen and select “MA”.
- In order to choose your preferred time of the indicator (SMA, EMA, WMA or SSMA), select it in the “Set Up & Apply” tab. You can also change the period of the indicator and its color.
- If you wish, you can click the “By default” button to reset the settings back to the default ones. Once you have chosen the necessary settings, click “Apply”.
Once it is done, you are ready to use the Moving Average indicator!
Important tip
As a general rule of thumb, longer term trends can be captured using SMA with longer periods, while shorter term trends can be captured using EMAs with shorter periods. Short term EMAs will look choppier, and long term SMAs will look smoother.
Conclusion
Moving averages are simple yet extremely handy, and they come in many forms. Each of them is ideal for its own job. Moreover, moving averages are great companions for other indicators as together they form powerful combinations for traders’ strategies.
