THE MOVING average is one of many tools you can use to extract gains from FX markets. It is a technical lagging indicator, derived from the average closing prices of a desired period, and is one of the oldest and most common forms of technical analysis.
The central benefit of the moving average is that it reduces market noise. A reduction in noise may give a clearer picture of the market, which ultimately may align probabilities to ones that favour a successful trading opportunity.
Since the moving average is a lagging indicator, it comes with a variety of advantages and uses. The ability to smooth out market fluctuations is one of them, but the major advantage is the ability to identify the trend. As Dow theory states, prices trend and trading with the trend may be advantageous. If you have an indicator that supplies such information, this may be beneficial.
When prices trade above the moving average, there is a strong likelihood that we are in an uptrend, and when prices trade below, we are most likely in a downtrend. The moving average may also be used to spot the end of a trend and act as an entry/exit signal. Prices simply need to cross above or below the moving average.
Like most other technical indicators it also comes with an array of settings, but the default is the 20 SMA. The 20 SMA shows you the average closing prices from 20 periods back. The other common periods used are the 100 and 200. More experienced traders may use the EMA (exponential moving average) with a customised period of their choice.
Lukman Otunuga is a junior currency analyst at FXCM.
For more information about moving averages and how to use them within the FX markets, please visit http://bit.ly/DFX-MA