How to Use Moving Averages in Forex Trading

On the foreign exchange market, moving averages are some of the oldest indicators that can be used to draw trends, reversal patterns, and support and resistance levels. This is an elementary but effective tool which reflects the behavior of past prices, eliminating short-term oscillations to show where a particular currency pair could be moving to. The knowledge of how using moving averages work can be quite beneficial to anyone that is involved in the forex trading business.

A moving average can be calculated by using the average of the closing price of a currency pair for a given period. For instance, the 50-day moving average is the average of closing prices of the stocks for the previous fifty days. There are two main types: The first type is the simple moving average (SMA), which equally divides the period’s prices, as does the exponential moving average (EMA), which gives greater weightage to the latest prices.

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The simplest use of moving averages applied by traders is that of identifying the direction of trends. The price above the moving average is a signal that the currency pair is in an upward move. On the other hand, if the price is located below the moving average, it means that there was a downward movement. This way, as a trader decides to look for the direction in which the overall trend is moving, then he or she is likely to select the right positions for the trade to be made.

There are also crossovers, which is the second strong indication given out by moving averages. Crossover is the situation whereby two moving averages of separate periods converge. For example, when the short term moving average such as EMA 10 crosses above the long term moving average such as SMA 50 it is referred to as a “golden cross”, which is a bullish signal. On the other hand, if the short-term moving average outlines below the longer one, then it is an indication of downward trending that is called the ‘death cross’.

Moving averages can also be used to identify the support and resistance levels. The moving average can also be used to identify the regimes of support and resistance. In an uptrend, a moving average tends to be a support line; when price comes to this level it can bounce back up. In a bearish trend it is used as a base line that may offer resistance to the price because the price may not easily go past it. An understanding of these levels means that the trader has an idea of where he or she wants to get in and out of a position.

When moving averages are used in conjunction with other indicators, the reliability of its results can be raised as well. For instance, incorporating the oscillators like Relative Strength Index index can give a confirmation of the prevailing trend or a reversal one. This ensures that traders are not relying on a single signal when making decisions

Before proceeding any further it is important to reiterate that moving averages are particularly helpful but not perfect. They are called leading indicators which simply mean that they are used to indicate past price action and not future prices. Any of them, when traded in the forex market, require a lot of patience, and the trader should never rely solely on a single indicator, but utmost consideration should be given to the market when employing them.

In forex trading, the many fluctuations going on at any one time, can make it hard to assess and interpret the seemingly endless columns of data, which is where Moving Averages come in. With time and the appropriate approach they could be valuable tools in the arsenal of a trader seeking to move cautiously in the seemingly fluid world of currency trading.

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Sam

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Sam is Tech blogger. He contributes to the Blogging, Gadgets, Social Media and Tech News section on TechCavern.

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