What Is Moving Average?

One type of indicator which you'll see time and again as you are learning about Forex is the moving average (MA). Moving averages are lagging indicators—this means they don't predict price direction, but rather are calculated from past prices. There are four popularly used types of moving averages: Simple, Exponential, Weighted, and Smoothed. You will rarely see Weighted moving averages used in Forex, but we'll go over them anyway. Most traders prefer to stick with Simple and Exponential moving averages. The default is to calculate moving averages using closing prices, but you can also choose to calculate using High, Low, Open, Median, Typical, and Weighted prices. You'll be able to choose how to calculate your moving averages in your charting platform, unless you wish to calculate them manually.

Let's start with simple moving averages (SMA). A simple moving average is calculated by adding up the most recent N number of prices and then dividing that sum by N. What is "N"? It's called a period of moving average and you can set it in your charting software. It can take any positive integer value from 1 to infinity. It indicates how many days (or hours, or weeks, or any other chosen periods of time) you’ll be adding up. The general formula for calculating the simple moving average for a given moment of time is:



For example, you chose 5 as the number of days (period), and the Close prices for those are (from oldest to most recent): 1.3345, 1.3348, 1.3350, 1.3374 and 1.3325. Then the simple moving average can be calculated as:

SMA = (1.3325 + 1.3374 + 1.3350 + 1.3348 + 1.3345) / 5 = 1.33484

With an exponential moving average (EMA), the calculation is more or less the same, but the difference is that exponentially less weight is given to the older data. This is done to reduce lag. Here's a general formula to calculate the EMA:



Which means that the EMA for today is calculated based on the EMA value yesterday, today's price and the special multiplier α, which can be anything from 0 to 1 (the higher it is, the sharper is the exponential decline of the weight of the older data). In Forex, α for exponential moving averages is usually calculated as 2 / (N + 1), where N is the period of the MA.

For example, we have the same data and period as in the above example for SMA. Let's calculate α:

α = 2 / (5 + 1) = ~0.33

The EMA of the first day is considered equal to the price of that day:

EMA₁ = 1.3345

EMA₂ = 1.3345 + 0.33 × (1.3348 - 1.3345) = 1.3346

EMA₃ = 1.3346 + 0.33 × (1.3350 - 1.3346) = 1.33473

EMA₄ = 1.33473 + 0.33 × (1.3374 - 1.33473) = 1.33561

EMA₅ = 1.33561 + 0.33 × (1.3325 - 1.33561) = 1.33458

As you see, it's quite different from the result obtained using the simple moving average calculation.

A weighted moving average (WMA) is similar, except that in the case of an EMA, the weight given to each older point of data decreases exponentially. In the case of a weighted moving average, the weight decreases incrementally. In general case the WMA is calculated as follows:



If, for example, we choose the same data and period as in the examples above, we'll get the following result for the weighted moving average:

WMA = (5 × 1.3325 + 4 × 1.3374 + 3 × 1.3350 + 2 × 1.3348 + 1 × 1.3345) / (5 + 4 + 3 + 2 + 1) = 1.33475

Once again, the result is somewhat different from both SMA and EMA.

A smoothed moving average (SMMA) is like a mix of a simple moving average and an exponential moving average. In general, it's calculated the same way as the EMA except that the multiplier α = 1 / N:



Consider the same example with the same 5 pieces of data. Let's calculate the multiplier:

α = 1 / 5 = 0.2

The SMMA of the first day is taken as the price of that day:

SMMA₁ = 1.3345

SMMA₂ = 1.3345 + 0.2 × (1.3348 - 1.3345) = 1.33456

SMMA₃ = 1.33456 + 0.2 × (1.3350 - 1.33456) = 1.33465

SMMA₄ = 1.33465 + 0.2 × (1.3374 - 1.33465) = 1.3352

SMMA₅ = 1.3352 + 0.2 × (1.3325 - 1.3352) = 1.33466

Although it's different from all of three previous variants of the MA, as you see, it's closer to the result obtained with the EMA calculation.

The nice thing about charting software is that you don't have to learn all these formulas; your charting platform will do your calculations for you. All you have to do is choose the periods you want to calculate the moving averages across and let the software display them for you. Here is a MetaTrader chart of the daily GBP/USD showing all four types of moving averages applied to the close for a period of 14:



Simple Moving Average: Red
Exponential Moving Average: Blue
Weighted Moving Average: Green
Smoothed Moving Average: Orange

As you can see in the chart, exponential and weighted moving averages are faster than simple moving averages, and smoothed moving averages are the slowest of all. The longer the period of any moving average, the greater the lag will be.

What can you do with moving averages? Most people who trade moving averages use them either to provide context for other systems or on their own in crossover systems. Moving averages tend to act as support and resistance levels; a lot of people like to place a slower moving average and a faster moving average on their chart, and then wait for the faster moving average to cross under nr over the slower one. This can indicate an opportunity to sell or buy respectively. But one should also remember that moving average is not some magic trading tool and it will often fail.

If you have any questions or want to share some useful info regarding various types of moving averages, please feel free to reply using the commentary link below.

What Is Confluence in Forex?

In Forex, especially while studying technical analysis, you may hear the term "confluence" used in conjunction with trade setups. What is confluence and why should you care about it as a Forex trader?

Confluence refers to any circumstance where you see multiple trade signals lining up on your charts and telling you to take a trade. Usually these are technical indicators, though sometimes they may be price patterns. It all depends on what you use to plan your trades. A lot of traders fill their charts with dozens of indicators for this reason. They want to find confluence—but oftentimes the result is conflicting signals. This can cause a lapse of confidence and a great deal of confusion. Some traders add more and more signals the less confident they get, and continue to make the problem worse for themselves.

Most Forex traders who succeed do so with a minimal number of indicators on their charts. Two or three is a good number of indicators to aim for. Some traders use just one, and some use none at all—though it’s harder to find a good trade context if you don’t have any at all.

Here is a good example of using confluence to place a great Forex trade. Say you trade using price patterns formed by the candlesticks on your chart, and you see a pattern which signals a "buy" trade. While the price pattern itself might be all you need to be right 80% of the time, perhaps you’ve discovered that confirming the pattern with some confluence can help you to be right 90% of the time. Maybe you’ve tested and discovered that Fibonacci retracement levels can help you find a good context. If your price pattern which signals "buy" lines up with a Fibonacci retracement level which is acting as support, then that is a great example of an "A" trade confirmed by confluence (the price action and the Fibonacci level). Note how this is not a cluttered Forex system. Aside from the Fibonacci levels, there are no indicators drawn on the charts at all. All you’re looking at here are price patterns. You only overlay the indicator when you want to check the context surrounding a price pattern. If you notice that the retracement level matches up with a pivot point you’ve been keeping an eye on, that’s another form of confluence.

This is only one example of using confluence in Forex. There are many different ways to use confluence. Systems are as varied as personalities. Test different combinations of signals to determine the best Forex indicators for you to use. Experiment and see what gives you the best statistical results over a large number of trades using historical data. Maybe you’ll find that using confluence of moving average crossovers combined with Fibonacci levels gives you great results. Maybe you’ll discover that Bollinger bands used in conjunction with support and resistance tests well. One thing which is important to note is that when you experiment with confluence, you need to choose indicators which are independent of each other—not calculated using each other. Otherwise you will stack up time lag, which will decrease accuracy.

Confluence is beneficial because it does more than show you a good setup in isolation—it shows you a good setup in context of the market. This is essential in Forex to avoid fake outs, unexpected reversals and trading against the trend. In a way, most Forex systems are built on the idea of confluence. If you haven’t found a system you like, this is how you can start building one from scratch. A good system will show you what’s going on right now, and how it fits into the bigger picture—and how you can profit from that knowledge.