Moving Averages Forex Trading Strategies
Moving average is an easy-to-use indicator and is useful for traders to identify trends, buy and sell points, and stop-loss and take-profit points. There are two types of moving average indicators:
1- Simple moving average
2- Exponential moving average
Moving averages are lines plotted on a price chart that shows the average of the previous closing prices, depending on the setting you choose. For example, when you enter a 5 SMA setting for the simple moving average indicator, the indicator will create a line that will determine the simple average of the previous five closing prices, depending on the time-line you choose. If you choose a 15-minute price chart and input a setting of 5 in the SMA indicator, the indicator will show a closing price average of previous 5, 15-minute candles.
Simple moving average gives equal weightage to the price points to calculate the average. Exponential moving average, on the other hand, gives more weightage to the most recent price points.
How to use moving averages in your forex trading?
While you can successfully use a simple moving average in your trading strategy, the exponential moving average responds quickly to price changes, and hence provides a comparatively better picture of the price action. Let’s discuss how you can use moving averages in your trading strategy to enter and exit a trade and put stop-loss and take-profit.
This strategy is useful for traders who want to do intraday trading as the strategy uses a 15-minute price chart. Therefore, to start, open the currency pair you want to trade and put the price chart to a 15-minute time-frame. Plot three exponential moving average lines: 5-EMA, 20-EMA and a 50-EMA on the price action chart. As soon as you see the 5-EMA crossing over 20-EMA, and the 20-EMA crossing over the 50-EMA, it is a buy signal. The crossover suggests that the price is rising lately and that the price is moving for an uptrend.
Conversely, when you see the 5-EMA crossing over the 20-EMA, and the 20-EMA below the 50-EMA, you have a sell signal, which suggests that prices will move downwards from this point onwards.
As a forex trader, you should understand that you cannot rely on one strategy solely. The disadvantage with the moving-average strategy is that it is a lagging indicator, which means that it shows the trend with a lag. Therefore, while executing any strategy, you should ensure that you complement your technical indicator with another one that confirms each other.