When it comes to indicators that are commonly used in a trading chart, the moving average indicator would always be among them. This is a handy technical indicator that analysts, as well as traders, use to determine the support and resistance levels, price movement, and trend of the market. So, and how can you master the moving average?
Moving Average Computation
It is calculated by summing up data points of a particular asset over a specified time frame and dividing it by the total number of data points.
As an example, if you’re looking to find the moving average of 5 consecutive candles, you’ll have to sum up the closing values of each candle and divide it by 5. For every new candle with its new closing value, the computation will adjust in the same manner. Every new candle will present a new moving average – this is also the reason why it is called a ‘moving’ average. Furthermore, every moving average point starts at the end of the 5th candle (when referring to intervals of 5 time periods).
Connecting all the data points from each candle presents a smooth line that shows the direction of the trend and price movement. While the moving average cannot tell the next direction of the trend, it gives a possible scenario of the future market. Also, when combined with other indicators, the moving average proves to be a very useful indicator for technical analysis.
The moving average indicator can be activated by going through the list of indicators located in the upper left corner of the Pocket Option trading dashboard. To change the moving average settings, click through the pen icon of the moving average tab and set the type of moving average, period, and style.
Types of moving averages in Pocket Option
There are a few types of moving averages used in trading. Among the most popular types of moving averages are used in Pocket Option. They are as follows:
Simple Moving Average
The SMA or Simple Moving Average as its name suggests is the straightforward type of moving average indicator. It is calculated through the sums of the candle’s data prices divided by the total number of candles in a particular period. The data prices used for the formula can be taken from any parts of the candles such as the high price, low price, opening price, or closing price. Note however that the price should be consistent throughout the formula – ie, use high price throughout the other candles if preferred to use high price as data price.
A good advantage of using the SMA on charts is the smoother line that clearly shows market direction. Furthermore, it is less prone to significant swings and whipsaws brought about by strong price actions.
Exponential Moving Average
The Exponential Moving Average or EMA emphasizes the most recent price data for its data points. In response, the moving average line of the EMA is more responsive to the most recent price. Compared to the SMA, the line of the EMA is much closer to the candles and is more prone to curves from price swings or reversals as shown in the image.
The advantage of the EMA is that since it gives emphasis to the most recent data price changes, and exaggerates the data point levels on the chart, it gives a glimpse of the possible direction of the market. This is especially useful when trading binary options which predict direction instead of price, and for intraday trading.
Weighted moving average
The weighted moving average or WMA also gives more emphasis to the most recent price data and less emphasis to past price data. This type of moving average makes use of a ‘weighting factor’ which is spread throughout its formula.
The good thing about using the WMA is that since it assigns a weighting factor for each data point, it exaggerates the ma line on the chart. On the image, the WMA is much closer to the candles than the other moving averages. Using the WMA would be ideal for trading in short time frames where the slightest movement of the MA would indicate strong signals.
Smooth simple moving average
Lastly, the smooth simple moving average or SSMA is somewhat the same as the SMA or Simple Moving Average however the SSMA takes into consideration longer periods in determining its average. The advantage of using the SSMA with its consideration to longer periods is that it is less prone to false signals. While other types of moving averages move or shift quickly from small price changes, the SSMA remains at a slow-paced movement on the chart. This type of moving average is advantageous for those trading in long-term trading, or those who are looking to invest for a long time on security or asset.
How to use the moving average
The moving average is an excellent indicator for the possible movement or direction of the price. While it may not be adequate on its own, combining it with other indicators greatly improves its usefulness. Among the best ways to use the moving average on a chart is by using multiple numbers of moving averages of the same type.
By using two moving averages, we would be able to identify data points from long-term periods and short-term periods. The way to trade with two moving averages is to identify its intersections or when the lines cross each other.
In this example, we’ll be using SMA 5, and SMA 14 – the lower the period used, the closer the moving average to the candles.
Notice how every time the lower SMA is above the higher SMA, the trend is an uptrend. Whereas, when the higher SMA is above the lower SMA, the trend is a downtrend. Notice as well whenever both SMAs intersect – it is either above or below the trend.
These observations give the idea that using two SMA’s makes it easier to identify the trend of the market – whether for long-term or short-term. Also, the crossing or intersection of the two SMA’s show possible entry and exit points on the chart.
While using two moving averages on a chart can already prove useful in identifying trading opportunities, incorporating other indicators such as RSI, MACD, Stochastic Oscillator, and others can also deliver good technical analysis. One thing to remember however when using indicators on a chart is that, the more indicators you have on a chart – the more complicated it will look. And if the chart is complicated, it will be more difficult to make trading decisions. As much as possible, go with a few indicators as possible – this is the reason why many expert traders only use moving averages as their primary indicators.
If you want to check out this strategy with the moving average, try it out on actual charts without having to pay real money. Pocket Options come with a demo account where you can trade real-time with virtual funds.
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