The fast-moving world of forex trading can feel confusing when you're attempting to understand the prices that keep changing all the time. Every single second, currency pairs are either moving up or down or both, and making sense of it all in any kind of orderly fashion is a real hat trick for anyone attempting to do it because, quite frankly, it is doing the impossible.

And yet, this is the very basis of trading in any market, and forex trading is no different. And so, there are tools that traders use to try to get a handle on it all.

No matter if you are a total newbie to the world of trading who is just trying to grasp the basic concepts of market trends or if you are an intermediary trader who is attempting to tune up your already existing trading plan and strategy, understanding moving averages is crucial to your success in forex trading. This guide is intended to take you from basic concepts concerning this indicator to more advanced ways of using it.

What Is a Moving Average

A moving average is a tool for technical analysis that determines the average price of a currency pair over a defined duration. You can consider it a mathematical confines mathematical filter that takes price changes over a defined duration and smooths them together to yield a resultant change that, somehow, seems more trend-like than anything you would get from just looking at price changes. It, therefore, yields a price progression concept that gives one the illusion of seeing the price as being more trend-like.

Identifying trends is the main thing a moving average does. It does this by eliminating the random price movements that happen from minute to minute. If you look at a straight price chart, you see countless up-and-down movements that can be very distracting. The moving average shows you the picture that's a step further back, or in some cases, a step further forward. In the case of the picture that's a step further back, the moving average shows you the part of the trend you're in that you can see with more clarity.

Different Types of Moving Averages

Understanding the differences between SMA and EMA is crucial for creating effective trading strategies. Each indicator has its own special set of qualities that make it suitable for particular market conditions and trading styles.

Simple Moving Average (SMA)

The Simple Moving Average works by taking the average price of a stock over a set number of past periods, usually days, and then plotting it on a chart. To plot the SMA for today, you would take the price of the stock at equal intervals over the last 30 days (if you were using a 30-day SMA) and average those numbers. Then you would use that average as a point on the graph for "today" in your SMA.

How Traders Use Moving Averages in Forex

There are many functions served by moving averages in the field of forex trading. They confirm trends. They also generate signals needed to enter and exit trades. There are other functions moving averages serve, too. If you understand how and why these different functions work, you can effectively use moving averages in your own trading. This chapter covers all of that.

Trend Direction Confirmation

The most fundamental application of moving averages is in identifying the direction of the market. When the price is above the MA, it shows that a bullish trend is in effect; when the price is below, a bearish trend. This is a simple rule that forms the basis for many successful trading strategies.

Conclusion

To achieve success with moving averages, the secret is not to seek the "perfect" parameter, but instead to apply what you understand in a consistent, sensible manner as part of a larger trading system. Moving averages can be worked into many trading systems. For some, they form the backbone. Whether you are using the simplest of MAs—a 50-day SMA, say—for long-term trend identification or a complex crossover system for day trading, the MA signals you've been taught to seek should be combined with other technical analysis tools that you've been taught to use in tandem.

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