One of the best ways to use moving averages is to help determine the trend in forex. An experienced trader can pick up a trend via instinct from years of experience. For a new trader, you need to have a method of finding and confirming trends. New traders can learn the ropes first and use improvisations later, and after they hone their trade methods and gain the necessary experience.
The Moving average indicator indicates the mean instrument price value for a particular period. When you calculate the MA, you average out the instrument price for the same period. As the price evolves, its MA decreases or increases. The moving averages have many variations and are calculated based on high opening, closing, low prices, or calculations from the combined price levels.
Types of Moving Averages
There are four types of Moving Averages:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Smoothed Moving Average (SMMA)
- Linear Weighted Moving Average (LWMA)
MAs are the most common indicators in forex, futures, and stock trading. Traders and market analysts use MA to help in identifying trends in price changes, smoothing out noise, and whipsaws for indexes and securities. The different types of averages are calculated differently and over varying periods, which give different information to a trader. The type of MA and period used is a significant determinant in the strategies that traders use.
Some of the methods of identifying trends include the following.
1. Moving Average Price Cross Over
Moving average (MA) is one the best tools a trader can use by plotting a single moving average on the chart. When price action stays above the moving average, it indicates that the price is in a general uptrend/ bullish If the price stays below the moving average, it signals a downtrend/bearish.
However, this is too simple. If the USD/JPY has been on a downtrend, a breaking news report might make it surge upwards. As a trader, you jump on the opportunity and assume the pair will shift to an upward trajectory, and you buy.
Unfortunately, it turns out to be a false surge(whipsaw), and traders were reacting to the news first, then the downtrend continues, and you make a loss. Most successful traders plot several moving averages on their charts, not one. This allows them to indicate better whether the pair will trend up or down, depending on the moving average order. The faster MA (moving average) should be above the more sluggish MA and vice versa for a downtrend in an uptrend.
2. Swing Pivot Confirmation with Moving Average
This method compels you to focus on price action. It helps traders avoid overreliance on the indicator. You can confirm a bullish trend via swing pivots in that they either:
- Swing low forms above the MA
- The price pushes its way to a new trend high but do not touch the MA
You can confirm bearish trends in that they either:
- Swing high forms below the MA
- Price drops to new trend low but does not touch the MA
3. X Bars Above/Below X-Period Moving Average
This method points out a strong trend, and at this stage, the trend is firmly entrenched. If you wish to enter a new trend, this is not the method to use. However, if you want to confirm that a recent trend is one with assured momentum, this is the method to use.
This is not the most agile approach, but one that offers traders a formula to discover market trends. Used by an experienced trader, this method can be used as a robust market guide.
Using the above methods is more reliable than using the moving average cross-over. However, the extra reliability comes with a price, which is a delay. You cannot immediately confirm the trend. The key in using these methods s finding the appropriate tradeoffs in your trading plan’s context.
You need to thoroughly understand these methods and integrate them into your trading strategy for added success. This means you must understand the price action of each of these methods. Understanding these methods also allows you to use the powerful tool that is moving averages to predict trends.