There are two types of Forex traders and investors: those who prefer simple moving average, and those who prefer weighted moving average. While it is impossible to claim one of them as superior, it is possible to outline the qualities of simple moving average from the standpoint of those who prefer it.
What is simple moving average?
Simply speaking, simple moving average, or SMA, is the arithmetic average of closing prices over a number of days. In terms of Forex markets, simple moving average of a currency pair would be calculated by adding closing prices of said pair over a certain time period and then dividing the sum by the number of periods you used. For instance, if you are interested in a simple moving average of USD/EUR over the last ten days, you would look up the closing prices on each of those ten days, add them up, and divide that sum by ten – the number of days you were interested in. The result is the simple moving average of said currency pair.
Why is it important for a Forex trader?
Forex trend trading may sound simple enough, but getting in at the right time and staying just long enough to make that sweet, easy money is nothing short of a form of art. There are numerous trade strategies, and some of the more successful ones rely on simple moving average, among other things. The importance of simple moving average for those strategies cannot be overstated. In fact, the 200 simple moving average is how you determine if a trend is long or not. The number 200 refers to the number of days. Anything above 200 simple moving average is considered a strong and rising trend, while everything below 200 simple moving average is considered a mark of a trend in decline. It is so universally accepted, that 200 simple moving average determines how a stock or a currency pair is perceived, which can have a profound impact on the market as well as your bottom line. Naturally, there are simple moving averages for any number of days, and they are usually used in conjunction, but the 200 simple moving average is considered the standard in modern markets.
A fair warning
A simple moving average is just an average of previous closing values, and as such, need not necessarily indicate anything in terms of future performance. There are no guarantees that the trend will follow the prognosis to the letter. However, a lot of people monitor these things, and do take these predictions very seriously. While the prediction itself may not even come true, a lot of people will act as if it will, which in turn may make it come true in real life. If simple moving average indicates an increase in future value and people start buying that financial instrument (having seen the SMA), it will, in fact, drive the price up, just as SMA predicted. Except it didn’t actually predict it.