Moving averages are exactly what they sound like.  They show an average closing price over a specific duration.  Moving averages work to smooth out the erratic movements of the price action and more accurately show the trends that are in play.

Notice in the picture below, that despite the fact the price changes direction, the moving average stays smooth and continues climbing.

A simple average is calculated by adding together all the amounts in set and then dividing the sum by the total number of amounts.  In this case adding all the closing prices in a given duration and dividing by the number of closing prices used.

They are “moving” since for any given time period they use different set of closing prices and hence move along with the price.  Moving averages are referred to using the number of time periods that are being averaged.  So a 5 period simple moving average on a 1 hour chart will show you the average of the closing prices of the last 5 hours; a 10 period moving average on a 1 day chart will show the average of the closing prices of the last 10 days.

Moving averages are slow to respond to sudden changes in the price movement so don’t show fakeouts when changing direction.  However this slowness also means that they don’t show buying/selling signals for real changes in the trend.

They are also susceptible to anomalous spikes in the price during the period which will then affect the average for as many periods as the moving average uses.  Exponential moving averages are used to protect against such anomalous readings.

Exponential moving averages

Exponential moving averages are similar to simple moving averages described above however they give more weight to the more recent prices than the older ones.   This is useful as it makes it quicker to respond to changes in the price movements as well as diminish the effect of anomalous spikes sooner.   This faster response also makes it more susceptible to fakeouts and false buying signals.

Moving averages are often used as moving support and resistance levels as the price level will often bounce showing points entry points during a trend.  Just like regular support and resistance levels, these lines should be thought of as zones rather than hard levels of resistance/support.  Also just like regular support and resistance levels they can be broken through so once again, they should be used in context with other indicators, tools and news that may be available.

Notice in the chart below how the price touches on the moving average line and then change direction again just like on a regular support line.

In order to plot a moving average on the demo account metatrader software, click on the indicators button > trends > moving average. Insert the period you want to average and click ok.  The moving average should now be plotted on your chart.  You can open a demo account and download the MT4 software by clicking here

Next Lesson - MACD (Moving Average Convergence Divergence)