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About Me

Darren Winters is a self made investment multi-millionaire and successful entrepreneur. Amongst
his many businesses he owns the number 1 investment training company in the UK and Europe.
This company provides training courses in stock market, forex and property investing and since
the year 2000 has successfully trained over 250,000 people.

Wednesday, 21 May 2014

Moving Averages - What are they?

Technical Indicators -  Moving Averages

A potential part of the technical trader's toolkit consists of technical indicators. Their purpose is to assist in the analysis of price movement, and as such have no place in fundamental analysis. They are mathematical formulas that use past price movements to either confirm or predict price direction.

Confirmation type indicators are known as lagging indicators. They are effectively showing what's already happened (for example, confirmation of a trend), and they can be used as trading signals in as much as they may suggest for example a change of momentum in the market, or changes in trading volume.

The predictive indicators are leading indicators. The bars on the chart may be showing price action in one direction, and the indicator will either agree with the movement or be going in the opposite direction. This suggests at least a weakening of price direction as shown on the chart, and a possible turnaround.

To make these distinctions clearer we can look a common indicator used by many traders - the moving average.

We'll start with the moving average. This will appear on a chart as a coloured line, which is showing you the average price of a stock or a currency (or whatever you're trading) over a certain period. So for instance, in the case of a simple 10 day moving average, on day 1 the closing prices for the last 10 days are added together and divided by 10. On day 2 the process is repeated to plot a new point on the average. As the average is showing you what's already happened, it's a lagging indicator, but it's a useful visual tool to show you how current price is relating to recent direction (depending on the period of the average).

We also have an Exponential moving average, which is calculated to give emphasis to more recent prices. This shortens the 'lag', but it's still showing you past data. In fact, the greater the number of days in the average, the greater the lag. You can expect a 5 day moving average to be close to current price action and change relatively quickly in line with price change. A 200 day moving average, by contrast, will take a lot longer. An exponential moving average will change course sooner than the simple version, because it is made up of more recent prices. There's no clear advantage to using exponential over simple moving averages, it comes down to individual preference.

Moving averages give you a visual indication of trend. A rising average shows rising prices and an upward trend, and the reverse is true for a falling average. A chart may contain a number of moving averages reflecting short to long term trends. They are used by some traders as lines of support or resistance, and when they form certain patterns they can signal trading entry points, should that be part of the trading methodology. Crossovers are a good example. If the 10 day moving average crosses above the 20 we have a bullish crossover, and if it crosses below, it's bearish. It signals a change in momentum.

See the example below on the 15 minute chart for the Euro. The 10 day (black) MA has crossed the blue 20 day MA. You can see the price action taking a dramatic upturn, which triggered the crossover.

EUR/USD 15 minute chart
The chart has 10, 20 and 50 day MA's. It represents a shorter term trading strategy. If I was more interested in the long term I might use 50, 100 and 200 day MA's instead.

Moving averages are good indicators in strongly trending markets. Although they're a step behind current prices, they're showing you the way, so to speak.

Indicators are covered in much greater detail at my seminars. Please follow the links provided below for further details.

Darren Winters


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