Lesson 1: Moving Averages

Advantages of Using Moving Averages

Overview

  • Moving averages "smooth out" market rate fluctuations that often occur with each reporting period in a price chart.
  • The more frequent the rate updates - that is, the more often the price chart displays an updated rate - the greater the potential for market noise.
  • For traders dealing in a fast-moving market that is "ranging" or "whipsawing" up and down, the potential for false signals is a constant concern.


20-Period Moving Average
Comparison of 20-Period Moving Average to Real-Time Market Rates

The greater the degree of price volatility, the greater the chance that a "false" signal is generated. A false signal occurs when it appears that the current trend is about to reverse, but the next reporting period proves that what initially appeared to be a reversal was, in fact, a market fluctuation.

How the Number of Reporting Periods Affects the Moving Average

  • The number of reporting periods included in the moving average calculation affects the moving average line as displayed in a price chart.
  • The fewer the data points (i.e. reporting periods) included in the average, the closer the moving average stays to the spot rate, thereby reducing its value and offering little more insight into the overall trend than the price chart itself.
  • On the other hand, a moving average that includes too many points evens out the price fluctuations to such a degree that you cannot detect a discernible rate trend.
  • Either situation can make it difficult to recognize reversal points in sufficient time to take advantage of a rate trend reversal.


Candlestick Price Chart with three different moving averages
Candlestick Price Chart showing three different moving averages lines

Reporting Period - A generic reference used to describe the frequency by which exchange rate data is updated. Also referred to as granularity. This could range from a month, a day, an hour - even as often as every few seconds. The rule of thumb is that the shorter the time that you hold trades open, the more frequently you should retrieve rate exchange data.

This is for general information purposes only - Examples shown are for illustrative purposes and may not reflect current prices from OANDA. It is not investment advice or an inducement to trade. Past history is not an indication of future performance.

Trading FX and/or CFDs on margin is high risk and not suitable for everyone. Losses can exceed investment.