Moving averages are one the most used forex indicators. It’s arguably one of the best indicators for forex trading available on platforms like MT4 and MT5.
It takes the mean of previous closing prices of a currency pair for a specified period. This period can be days, weeks, months, etc.
The forex market moves in a wave-like pattern. Hence, market trends can be difficult to determine.
Forex traders can identify market trends with the help of a moving average.
A moving average smoothens and predicts the market’s direction. It also distinguishes a trending market from a ranging one.
This is a good tool for new traders because charts can seem overwhelming at first glance.
What Is The Best Moving Average To Use?
A moving average can be edited to suit different trading styles and the time frame in question.
Those with small periods are very sensitive to price changes. While moving averages with larger periods are less sensitive to price changes.
Moving averages with small lengths follow price way too closely.
Furthermore, moving averages with very large periods stray away from recent price action.
In general, the larger the period, the farther the moving average is from the current price action.
Backtesting is essential to finding the right balance.
Types Of Moving Averages
There are two types of moving average, namely;
- Simple moving average
- Exponential moving average
Simple Moving Average (SMA)
As the name implies, this is the simplest type of moving average. The principle behind a simple moving average is easy.
How To Calculate a Simple Moving Average
Knowing how the simple moving averages work is important. Traders can make adjustments for different purposes.
The formula to calculate a simple moving average goes thus;
SMA= A1 + A2 + A3 +… + An / n
A = Average in period n
n= Number of time periods
Plotting a 10-period simple moving average on a 30 minutes chart, the last 10 price closure on the 30 minutes will be added. That is, for the past 5 hours.
The sum of these prices is then divided by the period of the moving average (10).
To plot a 10-period moving average on a 1-hour chart, the last 10 closing prices of the last 10 hours are added then divided by 10.
Exponential Moving Average (EMA)
Unlike the simple moving average, an exponential moving average lays more importance on recent data
A 5-period exponential moving average places more weight on the last three price closures.
So, it responds faster compared to the simple moving average. Forex traders can identify trends earlier and make more profits!
But, this also means you will be vulnerable to fake-outs due to the high sensitivity.
How To Trade With The Moving Average Indicator
More accurately, dynamic support and resistance levels since they are never static.
Resistance is a price level where rising price halts i.e. sellers gain control.
Support, on the other hand, is a price level where falling price reverses to the upside.
Ideally, when the price of a currency pair is beneath a moving average, it is a sell signal.
On the contrary, when the market price is above a moving average, it is a buy signal.
Moving Average Forex Strategies
Moving Average Forex Strategy 1- The 3 moving averages crossover strategy
This strategy involves using three exponential moving averages of different periods. Using multiple moving averages allows you to gauge a trend’s strength.
In this case study, I will be using moving averages of 10, 20, and 50 periods.
Since this currency pair traded below all three moving averages, I’ll execute a sell order.
Before a trade is taken, it has to be ensured that the market price is above or below all three moving averages.
Moving Average Forex Strategy 2- The 2 moving averages strategy
I will use two simple moving averages here. A short-term moving average and a long-term one to indicate a trend.
The 200MA is used to determine trends while the 50-period MA is used for entries.
From the chart above, GBPUSD has been trading below the 200-MA, which tells me we are in a bearish market.
The 50-period moving average in this case acts as a dynamic support. This means that the moving average will reject price downside.
At these points, sell orders are taken.
Summary- How To Use The Moving Average Forex Indicator
The moving average forex indicator is a good tool for every trader. Market trends can be easily identified so trading experience is greatly improved.
But, as with any indicator or strategy, it is not flawless. The simple and exponential moving averages have their pros and cons.
The simple moving average responds slower to price. This means that trends will not be identified early but fake-outs are avoided.
An exponential moving average uses recent price action. They are liable to fake outs sometimes due to their high sensitivity.