Importance of Moving Averages in FOREX Trading

The moving average (MA) is another instrument used to study trends and generate market entry and exit signals. It is the arithmetic average of closing prices over a given period. The longer the period studied, the weaker the magnitude of the moving average curve. The number of closes in the given period is called the moving average index.

Market signals are generated by calculating the residual value:

Residual = Price (X) - MA(X)
When the residual crosses into the positive area, a buy signal is generated.
When the residual drops below zero, a sell signal is generated.

A significant refinement to this residual method (also called moving average convergence divergence, or MACD for short) is the use of two moving averages. When the MA with the shorter MA index (called the oscillating MA index) crosses above the MA with the longer MA index (called the basis MA index), a sell signal is generated.
Residual = Basis MA(X) - Oscillating MA(X)
Again, we use the EUR/USD currency pair to illustrate the moving average method. See Table below.

[caption id="attachment_13114" align="aligncenter" width="514"]Calculating Moving Average Residuals Calculating Moving Average Residuals[/caption]

By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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