If you’ve been a trader for some time now or has been reading up about Forex trading, moving averages might have come up once or twice in your reading material or training courses. While simple to use relative to other more complex indicators, like Ichimoku clouds and Elliot waves, moving averages are much harder to successfully apply in your trading. Below you’ll find what moving averages are and, more importantly, how it can be used to extract consistent gains in Forex.
What Are Moving Averages?
A vast majority of price patterns you’ll find in a simple currency pair chart will indicate a ton of variations in price action. As a trader, this can make it fairly perplexing to gauge the overall market trend. Moving averages aim to simplify price action by plotting the currency pair’s average price over a set period of time. The time interval is set by the trader, and can vary anywhere between a 1-minute chart to a monthly chart. Doing so smooths out price action by eliminating short-term price action that is irrelevant and less reliable.
Types of Moving Average
Since the indicator was created, there have been a variety of moving averages created based on the way it’s calculated. However, the method in which each average is interpreted remains true to its original version. The calculations only vary with the weighing of the historical data, with exponential moving averages shifting more weight from each data point to the most recent data points. Simple moving averages, on the other hand and as the name implies, uses the sum of all the previous closing prices over a set period of time and then divides the output by the number of data points used to derive it.
How to Use Moving Averages
Trend-trading is one of the most common ways people use moving averages with a Royal Capital Pro account. Many traders believe that a trending market environment is the only or at least one of the only reliable price patterns to put money on. Moving averages can be used to confirm a trend once it has established enough strength to merit being an actionable trade. Moving averages are often used only to confirm a trend since it tends to lag behind real-time price action and is therefore unable to predict new trends.
Other Trading Approaches That Use Moving Averages
Momentum trading is also a very popular play that involves the use of moving averages. Momentum trades, albeit, can be tricky for beginning traders to identify and trade effectively even with the help of moving averages. Still, short-term momentum can be measured by analyzing moving averages that are limited to a maximum of 20 days. Last but not least is support and resistance trading. Moving averages can be drawn in a price chart to determine levels where a potential reversal will occur.
Improving Trade Probability
When trading with moving averages, always supplement it with other analytical tools and try to look at the market context. For instance, if shorter time frames like 1-Hour or 4-Hour charts indicate moving averages trending upwards and yet the Daily and Weekly charts are showing an overextended bullish trend, it makes strategic sense to either refrain from entering any trades until new confirmation of bullish continuation is acquired or entering a short position in expectation of a reversal to the downside.
Moving averages can amplify gains by providing you with more information and giving you another perspective from which to trade with. Like any other tools, however, moving averages should not be used individually. Proper risk management measures should be set in place to minimize risk and protect capital.