Forex Exponential Moving Average Based Systems

A Moving Average is the technical indicator that shows the average value of a particular currency pair over a previously determined amount of time. This means, for example, that prices can be averaged over 30 to 60 days, or 20 to 40 minutes depending on the time frame you are using at the moment of your trading activity. The basic mechanics of Moving Averages tell you where the forex market is moving, either up or down, at the moment of your analysis by considering two different time frame Moving Averages and plotting them on a chart. It is very important that one of these MA is over a shorter time period than the other one. Many brokers offer this as part of their basic trading platforms.

An exponential moving average, which can also be referred to as an exponentially weighted moving average, applies weighting factors which decrease exponentially. The weighting for each older data point decreases exponentially, giving much more importance to recent observations while still not discarding older observations entirely.

The observation at a time period t is designated Yt, and the value of the EMA at any time period t is designated St. S1 is undefined. S2 may be initialized in a number of different ways, most commonly by setting S2 to Y1, though other techniques exist, such as setting S2 to an average of the first 4 or 5 observations. The prominence of the S2 initialization's effect on the resultant moving average depends on α; smaller α values make the choice of S2 relatively more important than larger α values, since a higher α discounts older observations faster.

Moving Averages are useful for smoothing raw, noisy data, such as daily prices. Prices can vary massively from day-to-day, obscuring whether the price is going up or down over time. By looking at the moving average of the price the underlying trends can be seen. Moving averages can be used to see trends, but they can also be used to see whether data is bucking the trend. Entry/exit systems compare data to a moving average to determine whether it is supporting a trend or starting a new one.

Therefore, the exponential moving average is only one type of a moving average. In the exponential moving average equation the most recent market action is assigned greater importance as the average is calculated. The oldest pricing data in the exponential moving average is however never removed and continues to influence the data, albeit on a sliding scale.

A buy signal occurs when the short and intermediate term averages cross from below to above the longer term average and a sell signal is issued when the short and intermediate term averages cross from above to below the longer term average. Longer term averages are used when trading only two exponential moving averages in a crossover system.

A 5-day exponential moving average normally will include more than 5 days worth of data and will include data from the entire life of the pair's movement. In fact, these moving averages might be better identified by their actual "smoothing constants," since the number of days of data in the calculation is the same for a so-called 5-day average as for a 10-day average. Exponential calculations can arrive at different moving average values depending on the starting point.

And if you are falling asleep about now, I can hardly blame you. There are many mathematical variations on the Moving Exponential Average as applied to forex trading, but they are all attempting the same thing: Trying to predict patterns in currency movements that will allow traders to enter and leave a position at the most profitable time in a currency shift. It is best to avoid systems where the owner or seller claims unreasonable levels of success. Forex trading is a risky business, and anyone who guarantees results in forex trading needs to be taken outside, thrashed within an inch of their lives and then quietly shot. With any system, there are risks involved and I do not believe it is possible to guarantee results in foreign exchange trading. Another thing to be aware of is that historical data is only one factor to take into consideration when attempting to predict future movements. See Forex Trading Guide for more detailed information regarding influences on foreign exchange values. Short term swings can expose a trader to untenable positions, particularly if high leverages are being used. Beware anyone selling a system that claims unreasonable success. Forex trading is a high risk occupation and data suggests most day traders lose money. Largely due to two factors - undercapitalization and use of over high leverage. There is no question that historical movements and values have a part to play in predicting future values - but that is only part of the equation.

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