Commander in Pips: Ok, here is fast look back at MAs. Let’s just point out the most important qualities of them:
1. There are a lot of different types of MA – simple, exponential, modified, smoothed, centered, weighted and maybe some others. But the most common are simple and exponential ones;
2. Any MA has two major parameters – the number of periods and price type. The number of periods shows how many trading periods will take part in the calculation of a particular MA, while the second parameter shows which price type that will be used in calculation from each period. Usually closing price is used, but it’s not forbidden to use MAs that are based on Low, High or even (High + Low + Close)/3. Use anything that will allow you to make money!
3. A special parameter of MA is displacement, sometimes it named as “Shift” or “Offset”. This parameter allows you displace MA forward or backward in time for a number of periods that you specify. This tool depends on the possibilities of your trading software and could be applied to any MA, because it does not depend on the type of MA. Displacement gives additional features to an MA.
4. Simple moving average, as it follows from the name is the simplest among the others, and its value is just an average of price values that are used in its calculation. The SMA calculation procedure puts equal weight to all periods price, that take part in calculation;
5. Exponential moving average (EMA) calculation puts more weight on the most recent price action.
6. Due to different weight application in calculation procedure of SMA and EMA, many traders point out that, at least theoretically, EMAs react faster to most recent price action, compares to SMAs – hence an EMA better shows real-time market sentiment and what is happening now, that is more important then historical sentiment. From the other side, an SMA is better at smoothing the different splashes and is not so sensitive to fake outs. This lead us to the conclusion that EMA is better for early trend catching but it prone to multiple fake outs, while SMA is less sensitive to fake outs, but also has a greater delay in trend identification. Although it follows from the math formulas, and theoretically is true, we can’t say that this fact has dominating importance in the practical application of EMA vs. SMA. Our view is that there is no solid advantage of EMA over SMA and vice versa.
Meanwhile, DMA has gained some more attention in our thoughts;
7. The greater the number of periods in the calculation any MA has – the smother it is;
8. Longer period MAs are slower to react to changes in price action, but better protect you from spikes and unwelcome splashes. Still, due to delayed reaction on the rapidly changing situation in the market, they could have a significant lag in trend changing and that, in turn, could lead to missing some good opportunities to enter the market;
9. You can use MAs for trend identification, as well as for entry points and trend changing points;
10. MAs could be used as support and resistance levels;
11. Also you can use combination of two or more MAs for the same purposes – trend identifications and support/resistance areas.
12. Applying MAs as a single trading strategy could lead to excellent results on a trending market which very rare ****s to consolidation, and poor results in a ranging market because of whipsaw price action;
13. Choosing procedure of suitable type and period of particular MA demands a lot of hard work. Furthermore, usually you will have to do this work again and again to find a suitable MA not only for particular pair, but also for different time frames.