Strategies with Moving Averages in the Forex Market - By DailyForex.com

Strategies with Moving Averages in the Forex Market - By DailyForex.com

By Dianne L. Fecteau

A moving average (MA) is an old and reliable tool used by traders to smooth price data. For example, a 20-day simple MA is the sum of prices for 20 days divided by 20. The smoothing makes it easier to see the underlying trend. Many traders use the MA for just this purpose alone.

In the chart below, you see that a 55 day exponential MA (in red) tends to follow the trend line fairly well on the EURUSD daily chart. As prices moved up from the bottom on the left side of the chart, the MA soon turned up as well.

In addition to displaying the underlying trend, there are three other ways you can successfully use a moving average (MA) in your trading.

The first is for determining support and resistance. In the Euro daily chart, you can see that the last three times price has approached the MA, it has served as support. The pair touched the line again on December 4, 2009 and it remains to be seen whether the EMA will again serve as support. You can experiment with different moving average lengths to see which ones are most effective, depending on the pair you trade and the period you use for trading.

A second way of using the MA is to indicate price extremes. If you examine prices compared to the 55 day EMA on the Euro chart, you see that prices moved well above the average on four occasions, once the uptrend was established. When the distance between price and the average increases, it’s a result of price deviating from its mean. When price returns to the average, it reflects the tendency of price to revert to a mean. Both situations present a trade opportunity. When price is at an extreme, there’s an opportunity to place a contra-trend trade. Since this would be trading against the prevailing trend, such a trade carries more risk. The more conservative trader can wait for prices to revert to the mean and then take a position that’s in the direction of the trend.



Finally, the trader can use an MA for specific signals. One such signal is when price crosses an average. Another is when a shorter MA crosses a longer one. In the EURUSD three-hour chart below, you can see four successful crosses of a shorter 20 EMA to a 50 EMA.



Note that in sideways periods of consolidation, this method tends to produce whipsaws.

The speed of the moving averages you choose will determine how many signals you receive from this approach. A 3-day MA will result in more signals from price crossing it than will a 20 day MA. Similarly, the length of time required for a 21-day MA to cross a 55 day MA will be longer than that required for a 3-day to cross a 5-day MA. You need to test various lengths to see which ones work best for you.

As always, safety demands that you use other methods in addition to the moving averages. Such methods might include price patterns, candle behavior, and indicator readings. However, this very basic tool can be a useful addition to trading decisions.

© Dianne Fecteau, 2009.