The Moving Average is one of the most popular indicators in technical analysis. It represents a method of smoothing price data and revealing a measure of trends.
It is calculated by taking the average closing price of a currency for the last “x” number of periods. This makes it a lagging indicator because the moving average always lags price action. As a consequence, it is best used to confirm trends and show market momentum.
There are two types of Moving Averages:
Simple Moving Average: gives equal weight to all periods included in the calculation.
Exponential Moving Average: gives more weight to the most recent periods of price action and reflects the more recent views expressed by traders in the market.
The example below shows a 20-period Simple Moving Average on a 15-minute chart. Every single point of the moving average is calculated from the average close price for the last 20 fifteen-minute candles:
There are several ways in which you can incorporate Moving Averages in your strategy:
- Using the Moving Average as a trend-following tool
Moving Averages smooth price fluctuations, allowing traders to see the underlying trend without being distracted by noise. An upward sloping Moving Average usually signals an uptrend, while a falling moving average indicates a downtrend.
One way of using this information is this:
– if the price of the currency pair is above the Moving Average, look for long setups.
– if the price of the currency is below the Moving Average, look for opportunities to get short.
The EUR/USD chart below serves as an example of how using the 20 Exponential Moving Average keeps your bias correct and puts the probabilities in your favor.
- Using the Moving Average as support and resistance
Moving Averages can provide support and resistance the same way that horizontal levels do. When price makes contact with the moving average, it can be used as an opportunity to get long (in an uptrend) or short (in a downtrend). Here is an example of the EUR/USD 4-hour chart where the 20 Exponential Moving Average gives several opportunities to join a strong downtrend:
- Using Moving Average Crossovers
Moving Average Crossovers occur when a faster-moving average rises above or falls below a slower one. Contexts like these can be used as signals to enter trades, both in trending or ranging markets. Here is an example where 20 and 50 Simple Moving Average crossovers provide you with entry and exit areas and help you profit from a nice down leg on the 30-minute timeframe:
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