Search ForexCrunch

Forex traders have been using moving averages for decades now and they are still one of the best ways to identify changes in trends. They can even be used for reversion strategies, by taking the opposite direction when a crossover occurs.

However, moving averages have one inherent flaw which is that they will always be lagging indicators. In other words, by using past data they will only identify a trend once it has already occurred. The problem is speeding up a moving average leads to overshooting the market and more whipsaws. Designing a moving average then, is a trade off between lag and curve smoothness. And what some traders may not know is that there are several types of moving averages out there that aim to solve this issue.

Guest post by FXTM

Simple moving average (SMA)

The SMA is the moving average everyone knows. It takes the simple average of the last x periods which means it is stable and signals trend changes relatively slowly.

Exponential moving average (EMA)

The EMA is probably the most popular moving average. It works just like the SMA but it gives more weight to recent values. What this means is that it responds more quickly to recent price moves than those further away. As such, lag is reduced and the EMA line is able to respond to the market trend more quickly.

Triple exponential moving average (TEMA)

As the name suggests, the TEMA seeks to reduce the lag of a typical EMA by tripling the weighting of recent prices. The TEMA is thus able to respond to market moves much quicker than the EMA or SMA. However, because of this, it sometimes overshoots the market and is not as smooth a filter. Overshooting leads to more whipsaws and unstable trade signals.

Adaptive moving average (AMA)

The AMA came about as a result of trying to improve on the original exponential moving average. Perry Kaufman expanded on the EMA by multiplying the weighting of the EMA by a volatility factor. By doing so, the AMA seeks to adapt more quickly to the market by indicating when volatility conditions change.

Hull moving average (HMA)

Trader Alan Hull’s attempt to solve the problem of lag versus smoothness, comes in the form of the HMA. Hull uses several weighted averages in his formula and claims by doing so he is able to reduce lag and increase smoothness at the same time.

Jurik moving average (JMA)

The moving average from Jurik research is a less well known moving average that is thought to be used by institutional traders. The makers of the JMA claim it is based on years of military research that used computers to track moving targets. Jurik say the MA is smooth and virtually lag free, the best moving average on the market. The formula is kept a secret which can be purchased as a locked indicator.