The moving average is a commonly-used indicator of the momentum behind the price movement of a security or currency. Day-to-day price changes can be erratic, and moving averages aid in removing some of the noise from price changes so that traders can make more intelligent trading decisions.
To create a moving average, the trader takes the average closing price of the currency under consideration over a set period of time. For instance, a 15-day moving average looks at the average price over the last 15 days. This average is then placed on a chart. The following day, the process is repeated, dropping the last day (now the 16th day) and averaging the most recent 15 days. The result is a chart that shows a much more gradual change in direction.
Moving averages are often employed in combination. For instance, a 15-day moving average may be compared to a 60-day moving average, which changes much more gradually. The advantage of using these two averages together is that they can provide an indication of a change of sentiment on the currency.
A single moving average goes up or down according to the combined opinion of all traders who have purchased or sold the currency. When the currency moves in a single direction, one moving average on its own provides sufficient information. However, say a 15-day moving average is trending upward but then starts to move downward. Traders want some indication as to whether this signifies a temporary anomaly or a long-term change of direction. Simply eyeballing the curve of the line is no better than guessing, so traders compare the 15-day average to another, such as the 60-day average. If the two lines cross, this is generally understood to signify a large-scale change in sentiment.
There are many variations on the moving average. Some traders use a weighted moving average, which provides greater emphasis to the most recent price activity, since this activity is most important in affecting the currency’s price. Other traders employ exponential moving averages in order to iron out anomalies. Moving averages may also be combined with other indicators in order to develop sophisticated analytical techniques based on support and resistance levels.