Moving averages are popular tools used by traders to discern where a market has been and where it is likely to go. By taking the average of recent market prices it is much easier to ignore the noise and focus on the real price.
This gives an objective price trend and shows where the market is most likely to go. There are several ways that forex traders can utilise moving averages in their trading.
Guest post by FXTM
1 – Moving average crossover
The most common way forex traders use moving averages is to use the moving average crossover. The theory is simple; when a faster moving average crosses over a slower moving average it signals that the price trend is going up. In other words the most recent data is going higher quicker than the older data. This is the best way to objectively see what is happening with the real price trend. The other useful thing with moving average crossovers is that they can be tested scientifically. By testing different moving average lengths, you can find the crossovers that are more likely to result in profitable trades.
2 – Above/below one MA
There are different types of moving averages available; simple, exponential, triple exponential, weighted and others too. They all essentially measure the same thing, the strength of the trend.
It’s therefore possible to use just one moving average in order to make trading decisions. When a currency is much higher than its 20 or 50 period moving average, it’s a signal that it’s overbought. Mean reversion traders will therefore sell when a currency is above its long term moving average and wait for a return to mean.
In the same way, if a currency is well below a moving average, it will most likely return to the average at some point in the future.
3 – On other indicators
Since moving averages are designed to smooth series of data they can be used for many other items, not just price. For example, if you have a choppy indicator such as ATR or Stochastic, or maybe you have built your own indicator, you can use a moving average to smooth that indicator and therefore make trading decisions more profitable. Simply plotting a moving average over another data series will smooth that data and will reduce the number of signals that the indicator produces. This will reduce overtrading and help to find better trades. You can use moving averages on nearly any price series. You could use it on volume, for example, to get a better idea for when volume is increasing or decreasing.
Further reading: 6 Steps to creating a robust forex system
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