Figure 1.2
Our objective is to take an idea and then to create a trading system from that idea. The reason we wish to create a trading system from our trading ideas is to see if the system could be profitable. It’s easy for us to take a glance at a chart and make observations about what may or may not work. It is quite another thing to create a trading system so that we can test to see how the observations we made perform over time.
The chart above is a daily bar chart of the EURUSD. The green line that you see on the chart is a moving average. In this case it is a 10-day simple moving average. We are starting our exploration of trading systems using the simple moving average because it is one of the most basic and widely used indicators. We may refer to the simple moving average as simply, “moving average”. We may also abbreviate simple moving average” as “SMA”.
The simple moving average we see in Figure 1.2 was created using the close data from the table below:
| Date | Open | High | Low | Close | Avg |
| 7/15/2015 | 1.10086 | 1.10348 | 1.09291 | 1.09463 | 1.10480 |
| 7/16/2015 | 1.09468 | 1.09619 | 1.08548 | 1.08741 | 1.10272 |
| 7/17/2015 | 1.08751 | 1.09060 | 1.08276 | 1.08296 | 1.09995 |
| 7/20/2015 | 1.08336 | 1.08694 | 1.08077 | 1.08244 | 1.09765 |
| 7/21/2015 | 1.08213 | 1.09683 | 1.08110 | 1.09366 | 1.09691 |
| 7/22/2015 | 1.09356 | 1.09660 | 1.08686 | 1.09280 | 1.09543 |
| 7/23/2015 | 1.09261 | 1.10173 | 1.09208 | 1.09833 | 1.09490 |
| 7/24/2015 | 1.09831 | 1.09950 | 1.09244 | 1.09758 | 1.09311 |
| 7/27/2015 | 1.09814 | 1.11287 | 1.09681 | 1.10872 | 1.09393 |
| 7/28/2015 | 1.10911 | 1.10987 | 1.10214 | 1.10594 | 1.09445 |
Table 1.1
To calculate the current 10-day simple moving average we add the closing prices of the last 10 days and divide the sum by the number of days.
Sum of last 10 days closing prices/10 = 10-day simple moving average
Here are the prices used in our calculation:
Sum of last 10 days closing prices 1.09463+1.08741+1.08296+1.08244+1.09366+1.0928+1.09833+1.09758+1.10872+1.10594 = 10.94447
10-day simple moving average = 10.94447/10 = 1.09445
As you can see, 1.09445 is also the same simple moving average shown in Table 1.1 for 7/28/2015.
You may be wondering why the price for the simple moving average in Figure 1.2 is 1.09537 and our calculation is 1.09445. The reason for this is that 1.09445 is the SMA for the last 10 days up to 7/28/2015. 1.09537 is the SMA for the last 10 days up to 7/29/2015 (this is the current day and as it is early in the day we don’t have the final closing price for the day yet.)
Merriam-Webster defines an average as, “a number that is calculated by adding quantities together and then dividing the total by the number of quantities”. The “quantities” we are adding together are the last 10d day’s closing prices. The “number of quantities is 10.”
The moving average gets its name because the average moves. In Figure 1.2 you can see the green line of our SMA move as the prices move. The SMA moves because it is recalculated with each new price bar. In our example, the SMA is calculated using the last 10 closing prices.
For further clarification, let’s take a look at Table 1.1. For 7/15/2015 we can see that the SMA is 1.10480. It was calculated using the daily closing prices from 7/1/2015 to 7/15/2015. On the next day, 7/16/2015 the SMA of 1.10272 is calculated using the closing prices from 7/2/2014 to 7/16/2015. On 7/17/2015 the SMA of 1.09995 is calculated using the closing prices from 7/3/2014 to 7/17/2015.
Figure 1.3
The most common SMA calculation uses closing prices, but other prices can be used as well.
Figure 1.3 shows us 4 different SMA’s. These 4 SMA’s were created using the price data that is used to create our bar chart in Figure 1.2; the open, high, low, and close.
The first SMA (dark-blue line) was created using the highest prices (highs) from the last 10 days. The second SMA (green line) was created using the closing prices (closes) from the last 10 days. The third SMA (light-blue line) was created using the opening prices (opens) from the last 10 days. The fourth SMA (red line) was created using the lowest prices (lows) from the last 10 days.
Though we will be using the closing prices in our calculations moving forward, the above example was shown to illustrate that a SMA can be created using prices other than just the closing price.
In our next section we will use our 10-day SMA to create a simple trading system for the EURUSD.
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