Let us assume that we have to obtain the average closing price for the last ten days. For this purpose, we total all the closing prices within this period and divide it by ten (number of days). A new closing price is added to the sum every new day, while the first closing price in the range, which was fixed eleven days ago, is subtracted from the formula. Thus, the moving average really moves after the price. In this example we consider Simple Moving Average, or just MA.
All this suggests quite a reasonable question, what period it is better to choose for work. There is no certain answer for this question, however, it is possible to be guided by the following rules. While changing a period it is required to remember that you make the indicator more sensitive by reducing the period, and the indicator will react to a price change more quickly. In this case you will always acquire more signals, but there will be more false ones among them as well. If to set a larger period, the indicator will react to a price change more slowly, you will acquire fewer signals, but at the same time there may also be fewer false signals
Mind that with a period increase the indicator becomes more leveled, and with the period reduction the indicator, on the contrary, becomes less leveled.
A more long-term moving average functions better at stable movement of the prices in a certain direction, i.e. at a strong trend. MA works better with a small period when the prices are in the stagnation phase and form the flat. Sensitivity of moving averages with a small period allows using even small price fluctuations. However, at a long-term stable trend “quick” MA sharply react even to slight market changes and may give signals for opening of positions contradicting with the main trend.Every professional trader selects MA period in a price moving history. While choosing the period, one may apply a small secret, for example, to put numbers out of Fibonacci sequence, on order not to make the work so endless.
1 1 2 3 5 8 13 21 34 55 89 144…
Each letter is the sum of the two preceding ones.
While using several moving averages on a price diagram simultaneously, some traders set the indicator periods so, that each indicator has a period twice larger that the period of the preceding indicator. Some other traders put Fibonacci numbers in one number or two numbers, etc. Moreover, it is possible to adjust periods for a certain cycle. For instance, period 5 on the day scale implies number of days in one working week. Period 24 on the hour diagram means the full day cycle, etc. Anyway, the work is labour-intensive, but interesting. It is not so easy to reach the balance needed.
At the next lesson we will consider application of two moving averages on a price diagram. Now, please, carry out the following task in order to remember the passed material better. With your software, download a moving average onto the day EUR/USD price diagram and try to increase and reduce the period in the indicator. Analyze, how decrease of MA sensitivity affects the signal “MA slope shows the trend direction”, which we considered at Part I.
Have a nice day! Alex Sabodin.
www.alpari-us.com
