One of the most useful of the differing charting tools used to predict Forex future prices is called moving averages.

What is the ‘Simple Moving Average’ (SMA)?

The SMA is calculated by dividing the total of the previous ‘N’ period closing/ending prices by the number of periods. These ‘moving averages’ all function with a delay which is because price data from a previous time is utilized to attempt to forecast how those prices will go in the future. Obviously though, this is by no means foolproof as previous trends are not guaranteed to be ongoing or replicable.

If for instance you wanted to plot the five period SMA on a thirty minute chart/graph, this would require the calculation of the average of the last five’s closing prices at thirty minute periods. Whilst this could be done manually, by far the easiest way to do this is by using charting software.

Here are some examples of SMA calculations for GBP-USD pair.

10 Minute 30 Minute 1 Hour
Time Quote Time Quote Time Quote
10:00 1.9722 10:00 1.9722 10:00 1.9722
10:10 1.9723 10:30 1.9726 11:00 1.9730
10:20 1.9725 11:00 1.9730 12:00 1.9732
10:30 1.9726 11:30 1.9731 1:00 1.9720
10:40 1.9728 12:00 1.9732 2:00 1.9716
SMA 1.9725 SMA 1.9728 SMA 1.9724

1) The 5 period moving average (MA) on a ten minute chart for GBP-USD pair equals 1.9725

2) The 5 period moving average on a 30 minute chart for GBP-USD pair equals 1.9728

3) The 5 period moving average on a 1 hour chart for the GBP-USD pair equals 1.9724.

Using longer periods when calculating your MA makes for a more comprehensible chart. It does however make your MA’s react more slowly to changes in prices. This becomes particularly prevalent in relation to SMA’s when factors contributing to the moving average are the same for all separate periods. One lone MA is however of little use because to establish what are the price trends in the Forex market, one has to chart a series of MA’s.

What are ‘Exponential Moving Averages’ (EMA’s)?

SMA’s are certainly beneficial when seeking to establish market trends in Forex but they can be prone to exhibiting ‘spikes’ and by necessity, they are reliant on old prices as well as newer ones. When constructing a Forex analysis, a trader must base a forecast on the most up to date prices that are available at the time. Put another way, this means that you would need to make a prediction based on what other traders are doing at that moment. What they did yesterday or a month previously is irrelevant. EMA’s enable traders to give greater consideration to recent currency trends rather than utilizing previous quotes or trends.
Let’s assume the daily closing prices for the GBP-USD currency pair are as follows:

Day 1 - 1.9722
Day 2 - 1.9727 (1.9650)
Day 3 - 1.9737
Day 4 - 1.9742
Day 5 - 1.9747

So the 5 period SMA on a one day chart would be 1.9735. This is higher than the price on Day 1 and therefore would suggest an increasing trend for the GBP-USD currency pair. Now if we assume the quote for Day 2 was 1.9650 - possibly because of an interest rate hike – then the SMA would then be 1.9720 which indicates a decreasing trend for the GBP-USD pair.

The response is to utilize the EMA which as mentioned, relies on more up-to-date, recent prices which demonstrate what the market is doing at that moment. In the examples above, as Day 2's closing price was 1.9650, the EMA would therefore be 1.9723. This includes ‘weighting’ factors such as, 0.1, and 1.9726, with a weighting factor of 0.2. The important thing to note here is that the higher the weighting factor, the more that reflects recent prices.

Having said that, you wouldn’t ordinarily need to manually calculate the EMA because you would use software that will do all that complicated calculating for you!