Moving average is the average of prices over a specified number of periods. It is a smoothed correlation between currency rates and time periods. The time period of any moving average defines how much it will be smoothed. For example, when a Moving Average is calculated by adding the closing prices for the last 5 bars, then it is defined as a 5-period MA.
Simple Moving Average — SMA:
SMA = (P1+P2+P3+….+Pn) / n
P= Price — price of i-bar. Usually closing prices are used.
n — MA period. This is a number of bars on which the indicator is calculated.
The main disadvantage of SMA is that it counts the price twice, when it is received and when it leaves the area of calculation. That is why improved variants of the indicator should be better used.
Weighted Moving Average (WMA):
WMA = (w1*P1+w2*P2+w3*P3+….+wn*Pn) / (w1+w2+w3+…+wn) wi — the so called weight or coefficient which is assigned to every price. The closer the price to today the larger coefficient is assigned.
Exponential Moving Average (EMA):
EMA(t) = EMA(t — 1) + (K x [Price(t) — EMA(t — 1)],
where t — current time period (current bar),
t — 1 — previous time period (previous bar),
K = 2 / (n + 1),
n — EMA period.
The main advantage of the Exponential Moving Average (EMA) is that it discounts both prices of the previous and current periods. Every subsequent value becomes more significant. MA length is better to choose for every specific instrument on which you trade and for every specific chart scale.
Some traders believe that it is better to use Fibonacci figures. For example, the following ones.
How to analyze Moving Averages:
If the price line crosses the Moving Average line from below, then this is a signal to buy. If it crosses from above, then it is time to sell.
The first method gives many false alarms as markets become faster each year.
That is why cross-points of two Moving Average indicators of different periods
are used (n1 and n2);
Moving Average indicators of a greater period may specify the trend themselves. When the value of the indicator is more than 40 it becomes less sensitive to price movements and indicates only the general direction of the movement (Trend);
The points of the most significant divergence of MA and the price chart indicate that the market is overheated greatly and correction is possible.Moving Average signals are more effective on a trend market and less effective when the market is flat. As MA is a lagging indicator, it gives many false alarms.
Source: Forex Killer