Moving Averages In Forex Trading

Moving Averages are one of the most popular financial indicators used by traders charting the Forex currency markets. They are one of the oldest and most popular technical analysis tools. Moving averages are defined as an average which is recomputed each time a new observation occurs. Moving Averages are commonly used as a tool for trend identification. Moving averages are used to identify an individual currency pairs trend in order to establish positions in the direction of the trend. When you are trying to handle accurate forex signal trading, one of the most useful tools you can use is the moving average indicator.

Simple Moving Average

The simple moving average is without question, one the oldest and most basic tools used in technical analysis. A simple moving average is considered a lagging indicator. In a simple moving average, the mathematical median of the underlying price is calculated over an observation period. Simple moving averages apply equal weight to the prices. Every day of the observation period is given the same weighting in simple moving averages. The simple moving average obviously has a lag, but the exponential moving average may be prone to quicker breaks.

Exponential Moving Average

An exponential moving average differs slightly from a simple moving average in that it gives extra weight to more recent price data. The shorter the exponential moving average is, the more weight that will be applied to the most recent price. Some traders prefer to use exponential moving averages for shorter time periods to capture changes quicker. Note that the exponential seems to react more quickly than the simple moving average, which could possibly signal a quicker entry or exit point for a trade.

Trend Identification

The purpose of the moving average is to show the trend in a smoothed fashion. When there is no trend, the moving averages are flat and pretty much useless. Erratic sideways markets tend to be represented by moving average lines that are flat or sideways, whereas markets that are beginning to trend strongly in one direction or another will begin that trend with a very angled moving average line. Conversely, in trending markets, moving averages can work extremely well. Moving averages are very important for not only isolating trends, momentum, and support/resistance, but more importantly, for highlighting the underlying bias of the dominant trading cycles.

Moving Average Trading Strategies

There are two ways in which a forex trader typically trades using moving averages:

1. If a currency pair price crosses its 50-period moving average trending downward, this could be interpreted as a signal to sell. Likewise, if the currency pair price crosses its 50-period moving average trending upward, this could be interpreted as a signal to buy.

2. When trading moving average crosses follow these rules - When your shorter moving average period crosses the line representing your longer period from the bottom, look for an opportunity to buy. Conversely, when your shorter moving average period crosses the line representing your longer period from the top look for an opportunity to sell.