Let’s look at what the Moving Average is and how can we use it in trading?
What is Moving Average
Moving Average or MA is one of the most used indicators in technical analysis. It is a way to smooth out market noise. By “moving average”, we mean that you take the average closing price of a currency pair for the last number of periods.
By calculating the moving average, the impact of random, short-term fluctuations on the price of a currency pair, metal, index (trading instrument) for a certain period of time is reduced. With an understanding of the moving average, any trader can build an easy and reliable forex strategy or add them to an existing one. They should certainly be present in any strategy. After reviewing the general things about Moving average, it is good to move on to the more interesting things.
Some of the most used moving averages are with periods 20,30,50 and 200.
This indicator can be used for both day trading and long-term trading (to leave the open position for a few days so that the signal can develop).
The strength of this indicator is that thanks to it you can determine the trend, you can also identify important areas of resistance and support.
We can have a buy or sell signal when the moving averages cross.
But this can be a signal for trend reversal as well. Moving averages are also used in other indicators in trading. One of it is MACD, where not only the intersections but also the divergences and convergence of the moving averages are monitored. Why use moving averages This is one of the most asked questions by start-up traders.
The first and most important thing is that when we look at moving averages we can immediately determine the price movement (trend setting), and as we know trading following the trend is the most profitable and least risky – The trend is our friend. This indicator reduces the noise in trading, or simply filters false signals. If we have the intersection of the moving averages from top to bottom and are at an angle, it means that a downward movement is formed and we need to focus on sales.
The same is true if we have a bottom-up intersection and it is still at an angle, then we have to look for purchases. But we will look at these things in detail in other articles. As mentioned above, moving averages can be used for resistances and supports. If we take some of the most used time periods of moving averages – 50 period, 100 period, and 200 periods, and apply them to the graph we can see that they acted as price support.
In this example, we are on the currency pair EUR / USD where we can see how a moving average works very well as support. In this way, we can take advantage not only by setting a trend but also to open buy-in places where it is repelled by the indicator.
But you have to remember something important, the price will not always repel exactly from the moving average, it can approach it and continue up, but it can also close below it and then continue up again. That is why it is very important to determine the trend of several charts. In this way, we minimize the risk.
Let us summarize if the price is above the moving average we expect an upward movement in the price of the traded instrument, and if the price is below the moving average we can expect a downward movement. But always look at the other charts, we do not trade on a single time frame. We will address this in other articles. Types of moving averages The moving averages can be calculated in different ways. The twenty-day simple moving average SMA collects the twenty new closing prices and divides them by twenty to create a new average each day. It then connects them and creates a flowing line. Another very common type of moving average is the exponential moving average EMA.
Here you should know that the calculation is a bit more complicated than SMA, this is because it applies more weight to the calculation of the latest prices. If you put a 100 daily moving average of any SMA, and on the same chart put a 100-day moving average EMA, you will see with the naked eye that the EMA reacts faster to price changes, and SMA reacts a little slower. This is due to the additional weighting of the latest data on the price. Here we emphasize that we give you this for general information. The software that you will use as MetaTrader 4 or Meta Trader 5, make these calculations yourself, you will not have to count.
As we can see from the graph, we have put both moving averages, but here we want to emphasize that one MA is not better than the other EMA.SMA can work better on the stock or financial market for a certain time, and in other examples EMA can works better. You should also know that the time value of the indicator is also very important. Whether the value is 50, 100, 200, etc. is very important for how effective it will be, and here it does not matter whether it is EMA or SMA.
The length of the moving average – the periodThe most common periods used are 10, 20, 30, 50, 100 and 200. This does not mean that you cannot enter your period, example 15. But before you do it you have to understand the moving averages very well, and to you invest time to test the indicator with a period of 15.These periods of the indicator can be applied to any time chart, from 1 minute to a month, depending on the trader’s trading style. This period, which we talked about a little above, is very important.
If you choose a period of 15, you should know that this moving average will be very sensitive, and will react very aggressively to the price than if you choose a moving average with a period of 100. smoother and filters more false signals.
As we can see from the chart we have made the 20 periods perioding average dark green and the 100 periodic average light green. So the 20 period moves closer to the price, it is used more by short-term traders, it can also be used and for scalping, but we will touch on this in other articles. This is because the 20 period monitors the price closely.
100 periodic can be used for long-term traders. It is good for the stock market because their trading is more long-term., they filter out a lot of false signals, but still give shorter signals. You only have to choose whether to use a moving alarm with settings below 100 periods, then you will have more frequent signals, but there will be more false signals, or use more than 100 periodic and receive fewer signals, but more reliable.
Here’s how you can choose your period. Choose your example 25 periodic moving average and give the graph behind so you can see in the story how it moved, and what signals it gave, and so on until you get to your number on the moving medium. Remember only one, for scalping by sensitive periods (smaller from 5 to 50) and for longer-term trading at leisurely at large intervals of periods (from 50 periods to 200).
Trading strategies – crossovers
This strategy is the most common among traders, it can even be said to be the most used. The first type is when the price crosses the moving average, it can be both from top to bottom and from bottom to top. Then the price signals for a trend change.
Another also widely used strategy with moving averages by traders is when we add a second moving average. But the two moving averages need different values, so to change the trend we have when one crosses the other, this can also be used as a signal to enter a position.
If the fast-moving average crosses the other from top to bottom, we have a sell signal. And the same but vice versa, if the fast one crosses the slower one from bottom to top, then we have a buy signal.
The same rules apply to changing the trend, when one crosses the other then we have a signal to wear out the current trend and form a new trend, the traded instrument.
Here’s what to look out for.
The first thing to remember is that these indicators should be in addition to your strategy, it is not good to rely only on them in trading. This is because sometimes when the price approaches a moving average, we are not 100% sure whether it will repel or break it. That’s why you need to filter the signals very well by adding additional indicators and monitoring the news of the day on a daily basis.
Moving averages work very well with clear trend movements. As we have shown in the last graph. To make little less mistakes with these indicators, you need to monitor them on several time frames, also combine them with at least one other indicator, thus increasing the chance of a quality signal, and filtering more from false signals. Before you start applying what you’ve learned in this article with real money, you need to invest time to learn the ins and outs of moving averages. Let your eye get used to these indicators.
Also, remember that in any business you have to invest 10,000 hours to become successful. In trading it is the same if you invest enough time and be consistent, things will happen.
Here is a broker where you can open a demo account with virtual money and start testing both MA and the addition of other indicators.