What Moving Averages Can Tell You
Moving Averages are one of the simplest yet most underrated Forex Indicators. When used correctly in conjunction with a Trading Strategy, they can really give the Forex Trader an added insight into the market.
In this blog post I want to take you through What Moving Averages Can Tell You and show you how they can be used.
Also, here is a YouTube video that will show you how to identify support and resistance levels using a simple 3 step moving average formula:
3 Step No-Nonsense Moving Average Formula: How To Identify Support And Resistance Levels In Forex
1. What Are Moving Averages
Moving Averages are quite simply a line, or lines, that span your Forex Charts. They show the average price of the market you are looking at over a specific period of time.
The main moving averages that are most commonly used in Fx Trading are:
The average price that the moving average shows you is based on the Moving Average that you select and the Forex Time-Frame that you are looking at. So, for example, if you are looking at the Daily Time-Frame and you add the 10 Moving Average - then the line that you see on your chart is showing you the average price of the market over the previous 10 days.
If you added the 20 day Moving Average to to same Daily Time-Frame, it would show you the average price of the market over the previous 20 days.
However, if you added the 20 day Moving Average to the 4 hourly time-frame, it would show you the average price of the market over the previous 80 hours, or 20 candlesticks.
Have a look at the Daily chart Euro/US Dollar chart below:
As you can see, the chart is a daily chart and, therefore, each candlestick represents 1 day.
The Moving Average that has been added is the 10 day Moving Average; Because the 10 day Moving Average is on the daily time frame chart, it is showing you the average price of the Euro/US Dollar over the previous 10 days, or the previous 10 candlesticks.
If you are feeling a little confused, do not worry - as with many aspects of trading - you do not need to understand the theory behind Moving Averages to use them effectively! However, it is worth having a basic understanding of what they are showing you.
2. What Can Moving Averages Tell You?
Moving Averages are mainly used for two Trading Strategies:
A. In trending markets as support and resistance levels
B. To indicate when a market reversal may happen
It is important to note here that Moving Averages are most useful in trending markets - that is markets that are in either an uptrend or a downtrend - in ranging markets they really don't show very much.
Using Moving Averages As Support And Resistance
In trending markets, Moving Averages are most commonly used as defining levels, to indicate where the market may bounce off and, thus, present traders with an entry opportunity.
These defining levels are known as support and resistance levels.
For example, you can see in the daily chart of the Euro/US Dollar below, that the pair is in a downtrend - forming a series of higher highs and higher lows, as indicated by the circles:
As traders, once we have found a downtrend or an uptrend, we would be looking to enter in the same direction as the trend - in this case a downtrend so we would be looking to sell the market or enter short.
That's where Moving Averages come in - we can find a Moving Average that the market has bounced off previously and indicate where the market may bounce off again - once the market reaches that Moving Average we can look to enter the trade.
If you take a look at the same Euro/US Dollar chart below, you can see that the 200 Moving Average has acted as a resistance level three times already, as indicated by the first three circles:
The last circle indicates where the market may rise to again and meet with the 200 day moving average - if and when it does, could present a trading opportunity.
of course, the same process works in an uptrend - the only difference is you would be looking for the market to be bouncing off the moving average below it - therefore acting as support as opposed to resistance.
Using Moving Averages To Indicate A Reversal
The second way to use moving averages, is as indicators of a reversal - as confirmation to the Fx Trader that the market is heading in the direction that he/she thinks it is.
I had a Forex Trading Mentor years ago who told me that you should always view entering a a market like a train leaving a station. When the person arrives at the station they are unsure of which way the train is going - only once the train starts moving in the direction that the person wants to go, should they board the train - entering the market is exactly the same and moving averages can provide you with confirmation of direction.
Let's have a look at the same Euro/US Dollar chart again. You can see that we have added the 5 and 10 Moving Averages:
You can see that when the 10 MA (the red line) crossed above the 5 MA (the green line), as indicated by the three circles, the market decreased. These three points also coincided with being just after the three times the market rose to meet the 200 MA.
Therefore, if you were looking to trade this market - you could wait for the market to rise back to the 200 MA, as your fist indication, and then wait for the 10 MA to cross back over the 5 MA. This would act as a second indication, or confirmation, that the market is moving in the direction you thought it was and, therefore, where your entry point should be.
At this point you would look to sell the market, or go short, to make sure you are trading in the same direction as the overall trend, which is down.
I hope this post has given you a bit more clarity on What Moving Averages Can Tell You and how you can use them. Don't forget to like this post and comment below with any questions you might have - I will be happy to answer them.
Until next time...