Moving Averages (MA) are inarguably the most commonly used technical indicators in the history of the forex market.
They are primarily deployed as trend indicators and can also spot support and resistance areas.
One of the key reasons why the moving average is an effective indicator is largely due to the vast number of traders that make use of them, hence transforming it into a self-fulfilling prophesy.
How It Works
Most of the moving averages are centered on closing prices, and their names makes it easy to explain i.e. a moving average is simply an average that moves.
A 14-day simple moving average is basically the fourteen-day sum of closing prices divided by fourteen.
Old data gets discarded as new data gets inputted into the averaging. This is one reason why the average moves along the time frame.
Find below on Fig. 1.0 an example of a 14-day moving average
Fig. 1.0
One first noticeable trait of the moving average is in its lagging features, which suggest that it is dependent on price action.
Moving Averages can be classified into two basic types – the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
Their names easily gives them away, the simple moving average explains the forex pair’s simple average over a period, while greater weight is given to the most recent price on the exponential moving average type.
Understanding Basic Moving Average Trading Signals
There are a several ways to which moving averages can be deployed on our trading charts, and here are a few noteworthy ones.
It is important to have it at the back of your mind that a moving average or a combination of it should never be used in isolation.
This is due to its lagging nature, hence it should be used in combination with other indicators as well as price action patterns in order to get things stacked in your favor.
1. Analysis of Market Trend
One of the most common use of moving averages is arguably trend analysis. Traders can shop from a wide array of moving averages they can use to analyze market trends.
A trader’s fondness for a simple average type will depend largely on his preference.
In this context, “moving averages” makes reference to both simple and exponential moving averages.
Critical information pertaining price is revealed by the direction of the moving average.
When a moving average is seen to surge on the activity chart, there is a corresponding rise in price, while a declining moving average indicator reveals a probable dip in the asset price.
If a long-term moving average rises, it is a reflection of a long-term bulls market.
A declining long-term moving average is indicative of a long-term bears market.
2. Double Crossovers
A combination of two moving averages can be attached to your charts to yield crossover signals.
Within the technical analysis community, this is referred to as the “double crossover method”.
This method involves a fairly short moving average and one relatively long counterpart.
Moving averages are measured according to their timeframe, hence a system that is made up of a 14-day EMA and 28-day EMA would be tagged short-term.
One that is comprised of a 100-day SMA and 200-day SMA is considered medium term, possibly even long-term.
A bullish crossover takes place when the longer moving average crosses below the shorter moving average with price aligned somewhat above both lines.
This process is referred to as golden cross in technical analysis.
A bearish crossover comes into account when the longer moving average crosses above the shorter moving, in a process that is tagged as a dead cross.
The ensuing moving average crossovers signals are basically late.
This is so true because the system deploys a set of lagging indicators.
The general rule for moving averages are easy to adopt i.e. the longer the periods of the MA, the greater the lag in its signals.
A trending market works great for crossover signals. Howbeit, a bunch of whipsaws is experienced in the absence of a strong trend.
Some traders will take the double crossovers a step further by adding another moving average to its setup, thereby transforming the setup into a triple crossover.
The signal setup is the same here i.e. the longest moving average crosses below or above the two shorter moving averages to produce a bullish or bearish signal respectively.
Double Exponential Moving Average Crossover Example
Fig. 1.1
3. Price Crossovers
Price crossovers is another setup pattern that takes advantage of the moving averages.
A bullish signal is generated when the moving average crosses below price, while a bearish signal is triggered when the moving average crosses above price.
To effectively use this strategy, the shorter moving average is used in triggering short-term signals, while the longer moving average sets the tone for the bigger trend.
Moving Average trading strategies for scalpers
We’ll use the triple crossover moving average trading strategy on the 1-minute chart to spot strong trends that can either be a buy or sell signal.
Our preferred pick is the combination of the 5-14-28 Simple Moving Average, which can be deployed on the 1-Minute, 5-Minute and 15-Minute forex chart.
One sure way to maintain profitable bullish/bearish signal is to wait for price to trade above the shortest moving average, which in this case is the 5-Minute Simple Moving Average.
Here’s an example of a forex scalping strategy with the 50 exponential moving average that work. Use it on the M1 or M5 charts for scalping purposes.
Moving Average trading strategies for day traders
In order to make lightning fast buy and sell decisions, day traders are on the lookout for a balanced feedback on short-term price action.
Smaller timeframes covered in multiple moving averages serves the purpose of allowing for fast analysis that highlights current risks along with profitable entries and exits.
Moving averages will serve as filters, offering market participants clues on when it’s most suitable to wait for favorable market conditions.
The 7-, 14-, and 35-bar simple moving averages gives a suitable fit for day trading strategies.
We’ve also highlighted here a moving average trading strategy that is formulated for day traders.
Moving Average trading strategies for swing traders
To get hold of profits when swing trading can become tricky, we must strike a delicate balance that allows us hold onto profits not too long to see them vanish before us, and exit too soon to see us miss out on big opportunities.
The use of short-term moving averages is suitable for swing traders who wish to identify when the trend may be shifting.
A strategy that is made up of the 6-period SMA crossing over the 11-period SMA and they both cross over the 20-period SMA is a fine example of moving average trading strategy for swing traders.
Please check out another example here of how moving averages can be incorporated into swing trading.
Conclusion
So far we have detailed how to extensively use moving averages, even though, there are loads of ways to deploy them as an integral part of your trading strategy.
The three methods that we’ve detailed here are our favorite and have worked for us over the years.
The simple moving average have one problem, which is their susceptibility to spikes.
This implies that they can give traders false signals, which could push us to think that a new forex trend may be emerging, but in reality, nothing changed.
Having a good understanding of how the moving average indicator works implies you can modify and build various strategies as the market environment develops.
We have shown a few examples of the workings of the moving averages and its inherent delay characteristics, which is as a result of taking the mean of historic prices.
Moving average strategies are good for viewing the overall path of recent past and the overall path of “future” short-term price action.
There are moving average lengths that are more popular than others, and it is important to find and make them an integral part of you trading strategy.
Less lag is experienced on the exponential moving averages, making it sensitive to recent prices changes.
This means the exponential moving averages will makes turns before the simple moving averages, and also exemplifies a vivid average of prices during the entire session.
A simple moving average is better suited to spot areas of support and resistance.