Moving averages are a widely used technical indicator in the forex market. Traders use them to identify potential trading opportunities and gauge the market’s overall direction.
Traders use two moving averages: simple moving averages (SMAs) and exponential moving averages (EMAs). Simple moving averages (SMAs) are calculated by adding up the closing prices of a currency pair over a given period and then dividing that number by the total number of periods.
Exponential moving averages (EMAs) give more weight to recent price data than SMAs. This moving average is calculated by adding a certain percentage of the current day’s closing price to the previous EMA.
Periods used for moving averages
The most common periods used for moving averages are 10, 20, 50, 100, and 200 days. Shorter periods will produce a greater degree of accuracy but may also be more likely to generate more false signals. More extended periods will produce fewer false signals and lag behind the market.
How to use moving averages
Traders can use moving averages in several ways, but the most common is using them as a trend following indicator. Once the price of a currency pair is above the moving average, it is generally considered an uptrend. Conversely, it is generally considered a downtrend when the price is below the moving average.
A crossover occurs when the price of a currency pair moves from one side of the moving average to the other, generally considered a bullish or bearish signal depending on the direction of the crossover.
Another way traders can use moving averages is to identify support and resistance levels. The 200-day moving average is often seen as a critical level of support or resistance for a currency pair. A break below the 200-day moving average is often a bearish signal. In contrast, a break above it is bullish.
The 100-day moving average can also be used similarly. Traders can also use moving averages to generate a buy and sell signal. One of the most common ways to do this is by using a crossover system which involves taking two different moving averages and waiting for them to cross over each other.
A buy signal is generated when the shorter-term moving average crosses above the longer-term moving average, and a sell signal is generated when the opposite occurs.
Another popular way to use moving averages is the Gold Cross System. This system uses the 200-day and 50-day moving averages. A buy signal is created when the 50-day moving average crosses the 200-day moving average. A sell signal is created when the 50-day moving average dips below the 200-day moving average.
While moving averages can be a helpful tool, traders should not use them in isolation. It is always advisable to use them with other technical indicators such as support and resistance levels, candlestick patterns, or Fibonacci levels, to see the full picture of what is going on.
Advantages of using moving averages
There are several advantages of using moving averages, including:
- They are easy to calculate and interpret.
- Traders can use them to identify trends.
- Traders can use them to generate a buy and sell signal.
- Traders can use them to identify support and resistance levels.
Risks of using moving averages
One of the main risks of using moving averages is that they can lag behind the market, which means they may not provide accurate signals in a fast-moving market.
Another risk is that indicators can generate false signals if the price action is choppy or there is significant noise in the market.
As with all technical indicators, it is essential to use them in conjunction with other tools and techniques to maximise your chances of success.
The final word
The most important thing to remember when using moving averages is a lagging indicator, which means that they will only provide you with information after the fact. It is essential to use them in conjunction with other technical indicators to get the most accurate reflection of what is happening in the market. Novice forex traders should use a reputable online broker such as Saxo Bank. Click here to contact them today to sign up for a free demo account.