FOREX

Forex Trading Methods - Elliott Waves

What is Elliott Wave?

The Elliott Wave principle is a form of technical analysis that attempts to forecast trends in the financial markets and other collective activities, named after Ralph Nelson Elliott (1871–1948), an accountant who developed the concept in the 1930s, he proposed that market prices unfold in specific patterns, which practitioners today call Elliott Waves. Inspired by the Dow Theory and by observations found throughout nature, Elliott concluded that the movement of the financial market could be predicted by observing and identifying a repetitive pattern of waves. In fact, Elliott believed that all of man's activities, not just the financial market, were influenced by these identifiable series of waves.

Elliott based part of his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott discovered the fractal nature of market action. Thus Elliott was able to analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns he had identified.

In the 1930s, Ralph Nelson Elliott found that the markets exhibited certain repeated patterns. His primary research was with stock market data for the Dow Jones Industrial Average. This research identified patterns or waves that recur in the markets. Very simply, in the direction of the trend, expect five waves. Any corrections against the trend are in three waves. Three wave corrections are lettered as "a, b, c." These patterns can be seen in long-term as well as in short-term charts. Ideally, smaller patterns can be identified within bigger patterns. In this sense, Elliott Waves are like a piece of broccoli, where the smaller piece, if broken off from the bigger piece, does, in fact, look like the big piece. This information (about smaller patterns fitting into bigger patterns), coupled with the Fibonacci relationships between the waves, offers the trader a level of anticipation and/or prediction when searching for and identifying trading opportunities with solid reward/risk ratios.

There have been many theories about the origin and the meaning of the patterns that Elliott discovered, including human behavior and harmony in nature. These rules, though, as applied to technical analysis of the markets (stocks, commodities, futures, etc.), can be very useful regardless of their meaning and origin.

Theory Interpretation

The Elliott Wave Theory is interpreted as follows:
- Every action is followed by a reaction.
- Five waves move in the direction of the main trend followed by three corrective waves (a 5-3 move).
- A 5-3 move completes a cycle.
- This 5-3 move then becomes two subdivisions of the next higher 5-3 wave.
- The underlying 5-3 pattern remains constant, though the time span of each may vary.
Let's have a look at the following chart made up of eight waves (five up and three down) labeled 1, 2, 3, 4, 5, A, B and C.



You can see that the three waves in the direction of the trend are impulses, so these waves also have five waves within them. The waves against the trend are corrections and are composed of three waves.

Impulse Patterns



The impulse pattern consists of five waves. The five waves can be in either direction, up or down:

Wave 1 - Wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower, the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.

Wave 2 - Wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% of the wave one gains, and prices should fall in a three wave pattern.

Wave 3 - Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. Anyone looking to "get in on a pullback" will likely miss the boat. As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three's midpoint, "the crowd" will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1 (also known as The Golden Ratio).

Wave 4 - Wave four is typically clearly corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than 38.2% of wave three. Volume is well below than that of wave three. This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, the most distinguishing feature of fourth waves is that they often prove very difficult to count.

Wave 5 - Wave five is the final leg in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high, the indicator does not reach a new peak). At the end of a major bull market, bears may very well be ridiculed.

Corrective Patterns

Corrections are very hard to master. Most Elliott traders make money during an impulse pattern and then lose it back during the corrective phase.

Wave A - Corrections are typically harder to identify than impulse moves. In wave A of a bear market, the fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull market. Some technical indicators that accompany wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.

Wave B - Prices reverse higher, which many see as a resumption of the now long-gone bull market. Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern. The volume during wave B should be lower than in wave A. By this point, fundamentals are probably no longer improving, but they most likely have not yet turned negative.

Wave C - Prices move impulsively lower in five waves. Volume picks up, and by the third leg of wave C, almost everyone realizes that a bear market is firmly entrenched. Wave C is typically at least as large as wave A and often extends to 1.618 times wave A or beyond.

An impulse pattern consists of five waves. With the exception of the triangle, corrective patterns consist of 3 waves. An impulse pattern is always followed by a corrective pattern. Corrective patterns can be grouped into two different categories:

1. Simple Correction (Zig-Zag)

There is only one pattern in a simple correction. This pattern is called a Zig-Zag correction. A Zig-Zag correction is a three-wave pattern where the Wave B does not retrace more than 75 percent of Wave A. Wave C will make new lows below the end of Wave A. The Wave A of a Zig-Zag correction always has a five-wave pattern. In the other two types of corrections (Flat and Irregular), Wave A has a three-wave pattern. Thus, if you can identify a five-wave pattern inside Wave A of any correction, you can then expect the correction to turn out as a Zig-Zag formation.



2. Complex Corrections (Flat, Irregular, Triangle)

Flat Correction - In a Flat correction, the length of each wave is identical. After a five-wave impulse pattern, the market drops in Wave A. It then rallies in a Wave B to the previous high. Finally, the market drops one last time in Wave C to the previous Wave A low.



Irregular Correction - In this type of correction, Wave B makes a new high. The final Wave C may drop to the beginning of Wave A, or below it.



Triangle Correction - In addition to the three-wave correction patterns, there is another pattern that appears time and time again. It is called the Triangle pattern. Unlike other triangle studies, the Elliott Wave Triangle approach designates five sub-waves of a triangle as A, B, C, D and E in sequence. Triangles, by far, most commonly occur as fourth waves. One can sometimes see a triangle as the Wave B of a three-wave correction. Triangles are very tricky and confusing. One must study the pattern very carefully prior to taking action. Prices tend to shoot out of the triangle formation in a swift thrust. When triangles occur in the fourth wave, the market thrusts out of the triangle in the same direction as Wave 3. When triangles occur in Wave B, the market thrusts out of the triangle in the same direction as the Wave A.



Conclusion

The premise that markets unfold in recognizable patterns contradicts the efficient market hypothesis, which says that prices cannot be predicted from market data such as moving averages and volume. By this reasoning, if successful market forecasts were possible, investors would buy (or sell) when the method predicted a price increase (or decrease), to the point that prices would rise (or fall) immediately, thus destroying the profitability and predictive power of the method. In efficient markets, knowledge of the Elliott wave principle among investors would lead to the disappearance of the very patterns they tried to anticipate, rendering the method, and all forms of technical analysis, useless.

Wave prediction is a very uncertain business. It is an art to which the subjective judgment of the chartists matters more than the objective, replicable verdict of the numbers. The record of this, as of most technical analysis, is at best mixed. Critics also say the wave principle is too vague to be useful, since it cannot consistently identify when a wave begins or ends, and that Elliott wave forecasts are prone to subjective revision. Some who advocate technical analysis of markets have questioned the value of Elliott wave analysis.

The Elliott Wave Principle, as popularly practiced, is not a legitimate theory, but a story. The account is especially persuasive because Elliott Wave has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method's loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.

Forex Trading - Parabolic SAR

In the world of short-term trading, experiences are defined by a trader's ability to anticipate a certain move in the price of currencies. There are many different indicators used to predict future direction, but few have proved to be as useful and easy to interpret as the parabolic SAR. The parabolic SAR is a technical indicator that is used by many traders to determine the direction of currency’s momentum and the point in time when this momentum has a higher-than-normal probability of switching directions. Sometimes known as the "stop and reversal system", the parabolic SAR was developed by the famous technician Welles Wilder, creator of the relative strength index, and it is shown as a series of dots placed either above or below currency’s price on a chart.



Calculation

The Parabolic SAR is calculated almost independently for each trend in the price. When the price is in an uptrend, the SAR appears below the price and converges upwards towards it. Similarly, on a downtrend, the SAR appears above the price and converges downwards.

At each step within a trend, the SAR is calculated ahead of time. That is, tomorrow's SAR value is built using data available today. The general formula used for this is:

SARn+1 = SARn + α(EP – SARn)

Where SARn and SARn+1 represent today's and tomorrow's SAR values, respectively.
The extreme point, EP, is a record kept during each trend that represents the highest value reached by the price during the current uptrend — or lowest value during a downtrend. On each period, if a new maximum (or minimum) is observed, the EP is updated with that value.

The α value represents the acceleration factor. Usually, this is set to a value of 0.02 initially. This factor is increased by 0.02 each time a new EP is recorded. In other words, each time a new EP is observed, it will increase the acceleration factor. This will then quicken the rate at which the SAR converges towards the price. To keep it from getting too large, a maximum value for the acceleration factor is normally set at 0.20, so that it never goes beyond that. For currency trading, it is preferable to use a value of 0.02.

The SAR is recursively calculated in this manner for each new period. There are, however, two special cases that will modify the SAR value:
- If tomorrow's SAR value lies within (or beyond) today's or yesterday's price range, the SAR must be set to the closest price bound. For example, if in an uptrend, the new SAR value is calculated and it results to be greater than today's or yesterday's lowest price, the SAR must be set equal to that lower boundary.
- If tomorrow's SAR value lies within (or beyond) tomorrow's price range, a new trend direction is then signaled, and the SAR must "switch sides".

Parabolic SAR

One of the most important aspects to keep in mind is that the positioning of the "dots" is used by traders to generate transaction signals depending on where the dot is placed relative to the asset's price. A dot placed below the price is deemed to be a bullish signal, causing traders to expect the momentum to remain in the upward direction. Conversely, a dot placed above the prices is used to illustrate that the bears are in control and that the momentum is likely to remain downward.

The first entry point on the buy side occurs when the most recent high price of an issue has been broken, it is at this time that the SAR is placed at the most recent low price. As the price of the currency rises, the dots will rise as well, first slowly and then picking up speed and accelerating with the trend. This accelerating system allows the investor to watch the trend develop and establish itself. The SAR starts to move a little faster as the trend develops and the dots soon catch up to the price action of the issue.

Parabolic SAR and the Short Sale

The parabolic SAR is extremely valuable because it is one of the easiest methods available for strategically setting the position of a stop-loss order. As you become more acquainted with technical indicators, you'll find that the parabolic SAR has built up quite the positive reputation for its role in helping many traders lock-in paper profits that have been realized in a trending environment. You can also see that professional traders who short the market will use this indicator to help determine the time to cover their short positions.

It is important to note that this indicator is extremely mechanical and will always assume that the trader is holding a long or short position. The ability for the parabolic SAR to respond to changing conditions removes all human emotion and allows the trader to be disciplined. On the other hand, the disadvantage of using this indicator it that the signals can lead to many false entries during periods of consolidation. Being whipsawed in and out of trades can often be extremely frustrating, even for the most successful traders.

Complimenting SAR with other indicators

Given the mechanical properties of the parabolic SAR, it is no surprise that it is a favorite among traders who develop their own strategies. In trading, it is better to have several indicators confirm a certain signal than to solely rely on one specific indicator, so most traders will choose to compliment the SAR trading signals by using other indicators such as stochastics, moving averages, candlestick patterns etc.

For example, a reversal of the dots from below the price to above is much more convincing when the price is trading below a long-term moving average than when it occurs when the price is above the moving average. Having the price remain below a long-term moving average suggests that the sellers are in control of the direction and that the recent reversal could be the beginning of another wave lower. Furthermore, a signal is considered stronger each time that an additional indicator confirms the same trend.



Conclusion

The parabolic SAR is a fairly good tool for traders looking for a strategic method of gauging a stock's direction or for portioning a stop-loss order. As illustrated above, this indicator proves to be extremely valuable in trending environments, but it can often lead to many false signals during periods of consolidation. This indicator is simple to implement into any strategy, but like all indicators, it is usually best if it is used in conjunction with other indicators to ensure that all information is being considered.

Advantages To Foreign Currency Trading

Do you want to get into foreign currency trading, but aren’t sure how it can benefit you? There are many advantages to foreign currency trading. First, in the last few years, the spread rates have tightened a lot. Most of the online FOREX brokers today will offer you a five pips spread on EUR/USD. This is the most widely traded currency pair.

United Bank celebrates golden jubilee

KARACHI: United Bank Limited (UBL) has produced an audio CD, comprising songs and narratives, based on selected works of Pakistan s revered national poet-philosopher Dr Mohammad Iqbal, to mark the bank s Golden Jubilee this year, it said in a press release. Incorporated on July 27, 1959, UBL started operations in November the same year. Its operations now extend to 11 countries outside Pakistan, through 17 branches, representative offices, subsidiaries and joint ventures apart from over 1100 domestic branches. Emphasizing the relationship between UBL s vision and Iqbal s ideals, President and CEO of UBL, Atif R Bokhari states: As fa progressive banking organization, UBL is aptly suited to embrace a national icon such as Iqbal, whose ideals embody the spirit of this institution. The CD contains original compositions of songs and narrations by some of the most outstanding composers, singers and artistes in the country. Introduced in UBL s Golden Jubilee year, this audio CD is a humble contribution towards propagating the message of Iqbal, particularly at a time when the nation needs his inspiration the most, and may be seen as a fitting tribute to the spirit of progressiveness, it added.

Why do Forex Brokers Pay or Take Overnight Interest?

With most Forex brokers when you leave a currency pair position open over the night you’ll get a swap or an interest payment for it. It can be positive (you actually gain money) or negative (you lose money). That payment is usually very small and the majority of the beginning traders just don’t pay any attention to it, since their direct profit or loss from the trading is much greater than this rollover interest. But why do the brokers pay and take this overnight interest payment or swap?

Forex Trading - Moving Average

Moving average is one of the most popular and easy to use tools available for doing technical analysis. It means the average price of a currency over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations. Moving average data is used to create charts that show whether a currency’s price is trending up or down. They can be used to track daily, weekly, or monthly patterns. Each new day's (or week's or month's) numbers are added to the average and the oldest numbers are dropped, thus, the average "moves" over time. In general, the shorter the time frame used, the more volatile the prices will appear, so, for example, 20 day moving average lines tend to move up and down more than 200 day moving average lines. There are four different types of moving averages: Simple (also referred to as Arithmetic), Exponential, Smoothed and Linear Weighted. Moving averages may be calculated for any sequential data set, including opening and closing prices, highest and lowest prices, trading volume or any other indicators. It is often the case when double moving averages are used.


The only thing where moving averages of different types diverge considerably from each other is when weight coefficients, which are assigned to the latest data, are different. In case we are talking of simple moving average, all prices of the time period in question are equal in value. Exponential and Linear Weighted Moving Averages attach more value to the latest prices. The most common way to interpreting the price moving average is to compare its dynamics to the price action. When the instrument price rises above its moving average, a buy signal appears, if the price falls below its moving average, what we have is a sell signal. This trading system, which is based on the moving average, is not designed to provide entrance into the market right in its lowest point, and its exit right on the peak. It allows acting according to the following trend: to buy soon after the prices reach the bottom, and to sell soon after the prices have reached their peak. Moving averages may also be applied to indicators. That is where the interpretation of indicator moving averages is similar to the interpretation of price moving averages: if the indicator rises above its moving average, that means that the ascending indicator movement is likely to continue: if the indicator falls below its moving average, this means that it is likely to continue going downward.

Simple Moving Average (SMA)

Simple Moving Average is the simplest type of moving averages. Basically, SMA is calculated by adding the last number in the period from the closing price, and then dividing that number with a period. Let me explain in example, if you select SMA 5 on a 1 hour graph, add the closing prices for the last 5 hours, and then divide that number by 5. If you select SMA 5 on a 30 minute graph, you will add the closing prices for the past 150 minutes (30*5), and then divide that number by 5. In the same way you can calculate SMA for any time period.

Most of the trading platforms will make all these calculations for you. The reason why I am bothering you with this component of technical analysis is because it is extremely important to understand how to calculate the moving average. If you understand how every moving average is calculated, you can make your own decision, which type is the best for you.

Like any other indicator, SMA works with a delay. Because you observe the average price, you are actually looking at the "forecast" of future prices, not the concrete future. Here's an example of how moving averages reduce the price activity:



On the previous chart you can see 3 different SMA. As you can see, the bigger period SMA you take, the more it stays behind the more prices. You probably noticed that the 62 SMA is much further away from current prices then 30 and 5 SMA. This is because with 62 SMA you are adding closing prices from the last 62 periods and dividing it with 62. The higher the number of periods that you are using, the slower is reaction to the movement of prices. SMA on this graph shows the overall sentiment in the market in a given period. Instead of just looking at the current price on the market, moving averages provide a broader view, and give us the general prediction of prices in the future.

SMA = SUM (CLOSE, N)/N ; Where:
N = number of calculation periods

Exponential Moving Average (EMA)

Although SMA is an excellent tool, one major problem is associated with it: SMA is very sensitive to sudden jumps (spikes). By looking at the next example you will better understand what I mean:
Suppose that we draw a 5 SMA on the daily chart of EUR / USD and the closing prices for the last 5 days are as follows: 1st day - 1.2345, 2nd day - 1.2350, 3rd day - 1.2360, 4th day - 1.2365, 5th day - 1.2370. SMA would be calculated as: (1.2345+1.2350+1.2360+1.2365+1.2370)/5 = 1.2358. But what if the 2nd day price was 1.2300? SMA result would be much lower and you get the impression that the price is going down, when in reality, 2nd day may perhaps have been only one remote event (for example, reduction of the interest rate).

What I am trying to indicate is that the SMA may sometimes be too simple. If there was only a way to filter the jumps so that we do not get the wrong picture and make the most out of moving averages. It exists and is called the Exponential Moving Average (EMA).

EMA is a type of moving average that is similar to Simple Moving Average, except that more weight is given to the latest data. The Exponential Moving Average is also known as "Exponentially Weighted Moving Average". This type of moving average reacts faster to recent price changes than a Simple Moving Average. In our example above, EMA would put more weight on the 3rd-5th day, which means that jump on the 2nd would have a lesser value and would not influence so much on the moving average. It would put more emphasis on what traders are doing right now. While trading, it is more important to see what merchants are doing right now, not what they were doing last week or last month.



EMA = (CLOSE(i)*P)+(EMA(i-1)*(100-P)) ; Where:
CLOSE(i) = the price of the current period closure
EMA(i-1) = Exponentially Moving Average of the previous period closure
P = the percentage of using the price value

Smoothed Moving Average (SMMA)

A Smoothed Moving Average is sort of a cross between a Simple Moving Average and an Exponential Moving Average, only with a longer period applied. The Smoothed Moving Average gives the recent prices an equal weighting to the historic ones. The calculation does not refer to a fixed period, but rather takes all available data series into account. This is achieved by subtracting yesterday’s Smoothed Moving Average from today’s price. Adding this result to yesterday’s Smoothed Moving Average, results in today’s moving average.

In a Simple Moving Average, the price data have an equal weight in the computation of the average. Also, in a Simple Moving Average, the oldest price data are removed from the moving average as a new price is added to the computation. The Smoothed Moving Average uses a longer period to determine the average, assigning a weight to the price data as the average is calculated. Thus, the oldest price data points in the Smoothed Moving Average are never removed, but they have only a minimal impact on the moving average, which is similar to how an Exponential Moving Average places more weight on the more recent data.

The first value of this smoothed moving average is calculated as the simple moving average (SMA):
SUM1 = SUM(CLOSE, N)
SMMA1 = SUM1/N

The second and succeeding moving averages are calculated according to this formula:
SMMA(i) = (SUM1-SMMA1+CLOSE(i))/N ; Where:
SUM1 = the total sum of closing prices for N periods
SMMA1 = the smoothed moving average of the first bar
SMMA(i) = the smoothed moving average of the current bar (except for the first one)
CLOSE(i) = the current closing price
N = the smoothing period



SMA versus EMA

If you want a moving average which will match the movement of prices quite quickly, then the EMA with a short period (eg. 3, 5, 8) is the best choice for you. This may help to ''hunt down'' the trend in the early stage, which will result in higher profits. Specifically, the earlier you have caught the trend, the more you can ''ride'' through it, and you can make more money. The pitfall is that while using this type of moving average you can get a false signal which you won’t recognize and lose your investment. Since the moving average quickly matches the price, you can even think that a new trend is forming, but in fact it is just an abrupt jump, which returns to the starting position (spike).

With SMA the situation is completely opposite. If you want the moving average to respond more precisely and slowly to the price changes, then the longer period SMA is the best choice for you. Although slow responding to the price changes will save you from many possible pitfalls, the smaller SMA may also result in too much delay and missing of a good trade.



Uses for Moving Averages

There are many uses for moving averages, but three basic uses stand out:
1. Trend identification/confirmation
2. Support and Resistance level identification/confirmation
3. Trading Systems

Which is better?

Which moving average you use will depend on your trading and investing style and preferences. The Simple Moving Average obviously has a lag, but the Exponential Moving Average may be prone to quicker breaks. Some traders prefer to use Exponential Moving Averages for shorter time periods to capture changes quicker, while others prefer Simple Moving Averages over long time periods to identify long-term trend changes. In addition, much will depend on the individual security in question. Moving average type and length of time will depend greatly on the individual security and how it has reacted in the past.

The initial thought for some is that greater sensitivity and quicker signals are bound to be beneficial. This is not always true and brings up a great dilemma for the technical analyst: the tradeoff between sensitivity and reliability. The more sensitive an indicator is, the more signals that will be given. These signals may prove timely, but with increased sensitivity comes an increase in false signals. The less sensitive an indicator is, the fewer signals that will be given. However, less sensitivity leads to fewer and more reliable signals. Sometimes these signals can be late as well.

For moving averages, the same dilemma applies. Shorter moving averages will be more sensitive and generate more signals. The EMA, which is generally more sensitive than the SMA, will also be likely to generate more signals. However, there will also be an increase in the number of false signals and whipsaws. Longer moving averages will move slower and generate fewer signals. These signals will likely prove more reliable, but they also may come late. Each investor or trader should experiment with different moving average lengths and types to examine the trade-off between sensitivity and signal reliability.

Trend-Following Indicator

Moving averages smooth out a data series and make it easier to identify the direction of the trend. Because past price data is used to form moving averages, they are considered lagging, or trend following, indicators. Moving averages will not predict a change in trend, but rather follow behind the current trend. Therefore, they are best suited for trend identification and trend following purposes, not for prediction.

When to Use

Because moving averages follow the trend, they work best when a currency is trending and are ineffective when a currency moves in a trading range. With this in mind, investors and traders should first identify currencies that display some trending characteristics before attempting to analyze with moving averages. This process does not have to be a scientific examination. Usually, a simple visual assessment of the price chart can determine if a security exhibits characteristics of trend.

In its simplest form, a currency’s price can be doing only one of three things: trending up, trending down or trading in a range. An uptrend is established when a currency forms a series of higher highs and higher lows. A downtrend is established when a currency forms a series of lower lows and lower highs. A trading range is established if a currency cannot establish an uptrend or downtrend. If a security is in a trading range, an uptrend is started when the upper boundary of the range is broken and a downtrend begins when the lower boundary is broken.

Once a currency has been deemed to have enough characteristics of trend, the next task will be to select the number of moving average periods and type of moving average. The number of periods used in a moving average will vary according to the currency's volatility, trendiness and personal preferences. The more volatility there is, the more smoothing that will be required and hence the longer the moving average. There is no one set length, but some of the more popular lengths include 21, 50, 89, 150 and 200 days as well as 10, 30 and 40 weeks. Short-term traders may look for evidence of 2-3 week trends with a 21-day moving average, while longer-term investors may look for evidence of 3-4 month trends with a 40-week moving average. Trial and error is usually the best means for finding the best length. If there are too many breaks, lengthen the moving average to decrease its sensitivity. If the moving average is slow to react, shorten the moving average to increase its sensitivity. In addition, you may want to try using both Simple and Exponential Moving Averages. Exponential Moving Averages are usually best for short-term situations that require a responsive moving average. Simple Moving Averages work well for longer-term situations that do not require a lot of sensitivity.

Conclusions

Moving averages can be effective tools to identify and confirm trend, identify support and resistance levels, and develop trading systems. However, traders and investors should learn to identify currencies that are suitable for analysis with moving averages and how this analysis should be applied. Usually, an assessment can be made with a visual examination of the price chart, but sometimes it will require a more detailed approach.

The advantages of using moving averages need to be weighed against the disadvantages. Moving averages are trend following, or lagging, indicators that will always be a step behind. This is not necessarily a bad thing though. After all, the trend is your friend and it is best to trade in the direction of the trend. Moving averages will help ensure that a trader is in line with the current trend. However, markets, currencies spend a great deal of time in trading ranges, which render moving averages ineffective. Once in a trend, moving averages will keep you in, but also give late signals. Don't expect to get out at the top and in at the bottom using moving averages. As with most tools of technical analysis, moving averages should not be used on their own, but in conjunction with other tools that complement them. Using moving averages to confirm other indicators and analysis can greatly enhance technical analysis.