What are Moving Averages?
If you haven’t guessed it by the name, moving averages are an average price that moves! There are different types of moving average that we are going to explore in this section but essentially moving averages allow us to see the average price over a specific time period. Using a couple of simple methods we can begin to pick some very profitable trades using moving averages, so let’s find out the different types of moving average most commonly used in forex!
Types of Moving Average
Although there are many types of moving average for the purpose of this educational package we are going to be focusing on the 2 most common types, the simple moving average and the exponential moving average.
The simple moving average is exactly that, an average of price over a set timeframe. So in order to set your moving average you need to decide a timeframe you want, this timeframe is the number of candles you wish your moving average to cover. For example, if you were on the 1 hour timeframe and you wanted to see the average price for the last 12 hours you would want a 12 period SMA (simple moving average). However if you then swapped to the Daily timeframe, this 12 period SMA is now showing you average price over the last 12 days! So moving averages are timeframe dependent.
The Exponential Moving Average (EMA) is slightly different than this simple moving average because it puts a little more importance on recent price. This means the EMA moves slightly faster than the SMA however if there is a big spike in the market the EMA will be more prone to showing this false spike and may mess up your trading strategy whereas an SMA wouldn’t be quite as affected because it puts equal importance on all price. Typically traders tend to favour EMA’s or SMA’s rather than using a combination of both so ultimately it is down to you on what you prefer, a faster moving MA, or a more steady MA with less spikes. Some traders prefer to use the EMA’s due to their faster movement in the markets. Now let’s find out how we can use moving averages to find some profitable trading opportunities!
Common Moving Averages
Just before we get into some examples it is worth knowing some common period moving averages that traders use. Although you can pick any period, if you use the same moving averages as lots of other people you will all see the same thing and therefore enter the same trade and so more money is pushing the market in your direction and you’re more likely to make profit! Easy as that. So lets go over some common moving averages.
For trend trading we commonly see traders using 10/20 period moving averages as well as 20/50 period moving averages for even longer term trends. There is also the Fibonacci sequence 3, 5, 8, 13, 21 etc… and commonly see short term traders using 5/13 moving averages and medium term looking towards 8/21 moving averages! Now let’s get into some examples of using these moving averages.
Moving Average Trading Techniques
The first moving average technique we are going to look at is the moving average crossover. This is one of the easiest techniques to use and can also be extremely profitable!
Above we can see a great example of a moving average cross. Here we are using 2 EMA’s the 10 period EMA (red) and the 20 period EMA (blue). As we can see on the left of the EUR/USD 4 hour chart these moving averages ere moving lower indicating bearish trend. The crossover then indicates trend may change and so we can enter long positions on this crossover and we hold until the moving averages re-cross as shown towards the right of the screen. If we entered on the first cross and exited on the re-cross we could have made over 200 pips!
This crossover strategy works very well in trending conditions and can bring in some big pips. Now lets look at another scenario of the very same trade but using a different technique, this time we will look to use moving averages as support and resistance.
Above we can see another way of using moving averages. Highlighted are the areas where price came back towards the 20 EMA and rejected and moved higher. So here our 20 EMA is acting dynamic support. So we can buy each time price touches the 20 EMA and then simply close our positions when price crosses or breaks the 20 EMA as shown towards the right of the chart. This is another really simple trading technique using moving averages and we could have banked well over 300 pips across the 2 buy positions shown!