Summary: Moving averages are very useful tools for trading financial markets. The way to trade with these indicators is to plot different averages on a chart and then to look for crosses that they make. Such crosses can be bullish or bearish and they are great signals to trade a market.
A moving average is a trend indicator and therefore it is being applied to the actual chart and not below the candles as there is where the oscillators appear.
As a rule of thumb, the bigger the period the moving average takes into account, the stronger the support and resistance level will be and the more difficult for the price to actually break it.
Brokers like CornèrTrader offer plenty of trend indicators beside the classical moving average, but these indicators should be considered as powerful ones if people know how to use them.
There are different types of moving averages (MA) but the most popular and often used ones are Simple Moving Averages (SMA) and Exponential Moving Averages (EMA).
The difference between the two comes from the fact that the EMA is still changing in time due to its exponential feature, while the SMA remains plotted at the same level no matter what the future prices will show next.
As mentioned at the beginning of this article, the bigger the period the moving average is taking into consideration, the most difficult will be for price to break it. This is normal if you consider that the actual value of the moving average is being an average of the previous values in the past.
Therefore, for example, the MA50 takes into consideration the previous fifty candles on that time frame and averages than in order to plot the current value. If the MA50 is plotted on the monthly chart, then it will take into consideration the last fifty candles before plotting the current values.
Because of that, it is no wonder that sometimes the actual price is way above or below the moving average, as the bigger the period the moving average takes into account, the further that moving average will be the actual price.
The most popular periods to consider in setting up a trading pattern with moving averages are MA20, MA50, MA100 and MA200. Values bigger than MA200 are considered to be irrelevant for the medium to long-term picture, while values below MA10 are too small to offer valid information when it comes to support and resistance levels offered.
Plotting such moving averages on a chart would result in the following setup being created:
The chart above is the EURUSD daily timeframe and the four moving averages are plotted on the actual price candles. When the market is trending strongly, the moving averages are aligned in perfect order, with MA20 in red being the first one, MA50 in blue the second one, MA100 in brown the third one and MA200 in black the fourth one.
In a strong bearish trend, the order should be the same only that the MA20 will be the lowest moving average on the screen.
The idea to use different moving averages to trade the forex market is strongly related to finding two things: a market top or a bottom or when to add to a position in a strong bullish or bearish trend.
A strong trend is defined by moving averages being perfectly aligned and this gives the opportunity to sell the spikes in a bearish trend when the price is moving into MA500 or MA100. The opposite is true when the market is in a bullish trend, only this time the dips need to be bought.
A strong warning signal appears when the lower MA’s start crossing the bigger ones. In order to catch a possible reversal in a trend, look for the MA20 to cross the MA500 for the first time.
If the move continues and it crosses the MA50 as well, you’ll notice the MA50 will actually stop trending anymore and will show signs of reversing the previous trend.
A golden cross is said to be forming when the MA50 moves above the MA100, while a death cross means exactly the opposite (MA50 moves below MA100). Needless to say that the usual caveat applies here as well: the bigger the time the golden or death cross are forming on, the bigger the implications on the lower time frames are.
The chart above shows a golden cross that definitely indicates the beginning of a bullish trend, while the death cross a few months later tells us that staying on the long side is not feasible anymore.
Trading is not supposed to be that easy though as in reality signals are not that simple and trends do not reverse that fast after moving averages cross. However, the beauty of such a setup comes from the fact that it is extremely visible and a new strong trend simply cannot start without a golden or death cross to happen.
No one can say he/she didn’t see the reversing trend and therefore it is just up to the trader to adjust to the new setup.
Such a simple setup is powerful as well and it can be applied on any timeframe with different results. For example, on the monthly chart, a golden cross gives a buy signal while on the hourly chart a death cross may give a sell signal. If hedging is allowed for that respective trading account, then both positions can be taken.
The same simplicity makes it a valid setup for any currency pair and as a matter of fact for any financial product that can have a chart being plotted on the screen.
For scalpers (traders that are looking for short moves and small rewards on an intraday basis) even smaller moving averages can be used in order to find out the possible reversals on smaller time frames, but the principle is the same: if moving averages are perfectly aligned, a strong trend is in place, while if a cross is happening, the previous trend shows signs of weakness.
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