Muscle Up Those Averages by Ajay Pankhania
Back To The Basics
Trading the currency markets means you need to be well aware of global macro
and micro economic variables. But when it comes to trading these markets, simple
is better. Find out more through this example of the EUR/USD currency pair.
Moving averages, although simple, are sometimes underused. In extreme market
movements, moving averages have a smoothing effect. They are also vital and
fundamental to the foundations of indicators we know today, one of them being
the moving average convergence/divergence (MACD).
Bull or bear?
There are many types of moving averages. Two of the more popular ones are the simple
moving average (SMA) and exponential moving average (EMA). SMAs are calculated
by adding the price of the financial asset and dividing it by the number of observations
(See sidebar “Calculating Moving Averages” on page 30). In other words, you can
calculate a simple moving average as you would normally calculate an average. EMAs are a bit more complex and require more
computation. Nevertheless, you can use
both these moving averages to see who
has more muscle in a trend — the bear or
the bull. Both moving averages provide
a floor (support) or a roof (resistance) to
a financial asset.
Are they converging
The MACD is a popular indicator; it
is the difference between two EMAs.
If you take an average of a smaller
amount of data, your average will be
greater. In this case, it would apply to
a faster moving average (50-day) and
the opposite would happen for a larger
set of data (slower moving average,
that is, 200-day). It would be the difference
between these two averages (see
sidebar “Calculating MACD” on page
30). The signal line is the average for
the graph; usually a nine-day average
is used. You can use the MACD to see
whether momentum is picking up or
declining — if the MACD has rising
lows, then momentum is picking up,
and if it has lower highs, it shows that
the security is losing momentum.