Moving Average is one of the famous indicators used by forex traders to find opportunities in the price chart.
They use it for devising effective strategies, and spotting trends, and also it is a helpful tool for identifying support and resistance zones.
There are 2 popular Moving Averages that forex traders use:
- Simple MA
- Exponential MA
The Simple MA shows the average price over a specific period.
The EMA of Exponential MA tells the average price over these periods, using more recent data.
In this article, we explain the basic things a forex trader should know about Moving Averages, including some MA trading strategies.
What is Moving Average in forex?
Moving Average is an indicator that calculates the average market price of an asset over a specified period. The trader then uses this to find trends, thereby identifying trading opportunities.
Using MA, forex traders are able to gather information on price movement for a specific period. Through this information, they identify a pattern in the market, which helps them see the ongoing trend and take advantage of it.
Knowing the market’s direction is an essential part of trading forex. This is why indicators like the MA are so important. Traders are able to forecast price moves once they know the average market price over a period.
The MA is also comparatively easy to use as traders can compute this manually, not requiring any complex forex formulas. Moving average is simply the average price of a given asset over a specified period of time.
There are two types of Moving Averages, as we’ve stated.
Simple Moving Average
SMA tells the average price over a certain period, let’s say 50 days. To determine the average price of an asset over this period, simply add all closing prices for the 50 days. Then divide the sum by 50. The result is your SMA.
For a 10 day SMA, imagine that the closing price of the GBPUSD for the last 30 days is 1.3001, 1.3002, 1.3011, 1.3000, 1.3005, 1.3020, 1.2999, 1.2998, 1.3000, 1.3009.
The calculation will be 1.3001+1.3002+1.3011+1.3000+1.3005+1.3020+12999+1.2998+1.3000+1.3009/10
This results in an SMA of 1.3020 GBPUSD.
However, this may not present the entire picture of the price movement and trend. Because the market reacts to economic events and the news.
This is where the Exponential Moving Average comes in. It considers these other factors and presents the trader with the most recent price changes.
Types of Moving Average trading strategies in forex
The MA indicators can be used in different forms to trade on currency pairs. Let’s look at the different types of these trading strategies below:
Single Moving Average cross
Beginners find it easy to understand the price movements through the MA cross. It presents patterns that are easily recognized and understood and tells the best time to enter a LONG or SHORT trade.
The Single MA cross involves drawing a single line on the price chart. Choose specified periods between 0 to 100 days, or 50, 30, 20, 10, even 0 to 200 is workable.
A golden cross or uptrend cross occurs when the current price passes below your MA line. The death or downtrend cross takes place when the price passes above the MA line plotted on the chart.
An uptrend signals the opportunity for LONG/BUY moves, while a downtrend is a trigger to enter a SELL/SHORT trade.
This strategy is the simplest MA one and easy to understand. Although, it is not entirely reliable, as it does not consider other market factors, such as news and current events.
Double Moving Average cross
This strategy involves plotting two lines on the chart. One for a shorter time period and the other for a longer time frame. The longer time frame gives the trader an extended view of the market. Whereas the shorter one will present the most recent prices as the market reacts to news and events.
The trader still looks for Moving Averages here, but with the two lines. A golden or uptrend signal emerges when the shorter MA moves from below and passes over the longer Moving Average. This is the signal to take a LONG/BUY position.
A death or downtrend cross occurs when the shorter Moving Average moves from above and passes below the longer MA. It signals an opportunity to SELL or go SHORT.
Envelop MA strategy
Both strategies mentioned above are not so reliable. That’s because the forex market is dynamic, and trends can move in unpredictable directions.
The envelope approach strengthens the signal and lowers the volatility risks by including some ‘filters’ around the MA lines.
These envelopes are in percentage and are placed on top or at the bottom of the Moving Average.
The trader would place two filters or bands at strategic points, on top or below the Moving Average line. For instance, a 1% below and on top of the MA line, or a 5% filter.
There is an added line of support or resistance for the current price to break past with these bands. And it would prove the strength of the trend.
Most forex traders go bullish or LONG if the price moves past the line above the MA. Or they would go SHORT or sell if the price crosses under the MA line below.
It is safer to use this strategy only when the price proves to be going in a specific direction. So trades would be placed in that direction.
If the price is rising (uptrend), the trader can enter a BUY position once the price moves near the middle filter (MA). If the price is falling (downtrend), the trader can take a SELL trade as the price nears the middle band (MA).
For SELL positions, put a stop-loss order 1pip above the most recent high. For BUY trades, let the stop-loss be 1pip below the most recent price low. Consider closing the trade once the price moves to the lower band if it is a SELL trade, or once it gets to the upper band for a BUY position.
Moving Average Convergence Divergence MACD
This is a popular Moving Average forex strategy that involves using an average Convergence Divergence histogram to find opportunities. It is highly effective for momentum trading.
It involves the use of two Exponential Moving Averages and a histogram. Traders look for the point of ‘convergence’. That is the point where the two EMA lines converge or connect. Or they look for ‘divergence, where the two lines diverge or dissociate.
There are several approaches here, but the common one is the crossing approach. The trader BUYS or goes LONG when the shorter MACD line moves past the longer signal line from below in this case. Or they SELL or go SHORT when the MACD line moves past the signal line from on top.
Ribbon MA trading strategy
This strategy involves a few Exponential Moving Average lines or SMAs, between eight to fifteen EMAs, in some cases. The time frames can vary.
These lines form a ribbon-like look in the chart that shows the trader more information than the SMAs. The trader gets a clear visual of the trend and its strength. If the angles of the Moving Averages are sharper than usual, causing the ribbon to extend, this indicates a strong trend.
Here, traders also look out for how the price moves past the signal lines before placing their trades, as described in the strategies above. But make sure to choose the crossovers that show good signals.
Other types of Moving Averages
The Simple Moving Average and the Exponential MA are the common ones. There are other types of Moving Averages, including:
Linearly weighted Moving Average
This one is similar to the EMA in that it places emphasis on more recent price data. Although its calculation does not involve additions or arithmetical summations, it uses geometry to arrive at the figures. For instance, for a 10 day period MA, the weight of the last price would be 10, the one before will be 9, and so forth, till it gets to 1.
On your indicator window in the price chart, you have to set it to use the Linear Weighted method to use this form of MA.
It is not commonly used in forex trading, except by skilled and advanced traders.
Smoothed Moving Average
This MA computes the average price over a specific period, but it adds some historical data to it. It also emphasizes more recent price information as the market reacts to some factors.
Traders will have to set the indicators to use the Smoothed MA if they wish. Note that here, historical data affects the final results.
The Smoothed MA is not so popular because it is quite complex. But it is often embedded in automated trading strategies. Sometimes, platform owners include it in the custom indicators in trading platforms.
The basic ways to trade Moving Averages
For single MAs
- Go long or place a BUY if the price crosses the MA, moving upwards.
- Go short or take a SELL position if the price crosses the MA, moving downwards.
For double MAs
- Go long or enter a BUY position if the fast-moving MA crosses the slow one, moving upwards.
- Go short or place a SELL trade if the fast-moving MA crosses the slow one, moving downwards.
For MACD and MA
- Place a buy trade when the price and the MACD cross the MA line to move upwards.
- Place a sell trade when the price and the MACD crosses the MA line, moving in the same downward direction.
The importance of Moving Averages
Moving Averages provide different types of helpful signals to forex traders. Traders can recognize the best entry and exit points through these indicators.
The following trade signals can be attributed to Moving Averages:
Two moving averages can help identify crossing opportunities in the price chart. By combining short-term MAs with longer term ones, the trader can spot crossovers and trade them successfully.
The basic rules are:
Place a BUY when the short-term Moving Average crosses over the Longer term one upwards. This is also referred to as the ‘golden cross, as mentioned above.
Place a SELL trade when the short-term MA crosses the longer term Moving Average downtrend. This is known as the death cross’.
Resistance and support
Moving Averages help traders find the support and resistance areas. It is very useful for breakout traders.
The rule here is to look for where the price cuts across the MA line from on top. It indicates a support point and tells the trader that the price will move in an upward direction.
When the price meets the MA line from below, this shows the trader that there is a resistance. That means the price will continue on a downward movement, which is a bearish move.
The most common signal that Moving Averages provide is the trend signal. It tells traders if a price is swinging upwards or falling downwards. Higher MA shows the increase in the overall price of the asset, meaning a bullish market. Lower MA shows that prices are falling, which is a bearish condition. Using extended time frames can show you longer trends. If the MA is evidently increasing, you have an uptrend market and can place trades accordingly.
Other indicators used with Moving Averages
The RSI stands for Relative Strength Index and is a popular indicator used alongside Moving Averages.
It is also a momentum indicator, though it gets plotted on a separate graph. Traders often use it to determine the overbought and oversold zones in the market. That way, they can spot the best entry points to join the momentum.
RSI is also easy for beginners as it uses simple math calculations and easy chart analysis.
The RSI signal line is often set at a default overbought and oversold points.
For such an RSI setting, 70 means the asset is overbought, while 30 or below indicates oversold. If the RSI moves below 30, then moves past 30 again, it is considered an uptrend move and a signal to place a BUY trade.
But if it moves past 70, then drops below 30, which is the oversold line, it is considered a downtrend signal. An opportunity to enter a SELL trade.
Overbought means that the price of the currency pair is selling too high. The market would figure that soon enough and the price would take a dive.
In contrast, oversold indicates a price that is too low for the currency pair. The SELLERS at this point would not accept lower than this price, and it would rise higher soon.
Traders consider factors that may be causing these artificial price moves. They also combine the RSI with the Moving Average indicators to predict the market’s next direction.
Stochastic is another indicator commonly used with Moving Averages by technical traders.
This indicator helps identify points of a possible trend reversal. So, as the Moving Averages identifies the trend, Stochastic confirms it by showing the possible length of the momentum or where it would reverse and change direction.
Its signal results from computing the average closing price and comparing it to the trading range over a specified period of time.
The notable thing here is:
- Prices remain the same or higher than the previous closing price in an uptrend.
- Prices remain the same or lower than the previous closing price in a downtrend.
Like the RSI, it indicates when a currency pair is overbought or oversold. It measures the degree of change between prices for specified closing periods using scales.
Unlike the RSI, it measures this from 0 to 100. 80 means overbought. So if the stochastic line moves up to 80 or past it, it’s a signal to enter a SHORT trade.
20 is considered oversold. Therefore, if the line touches 20 or below, it indicates that prices will make a bullish move soon. A signal to enter a LONG trade.
Its signal is not too reliable. That’s why it is often used with Moving Averages to determine the market direction.
The Moving Average forex trading strategies are highly beneficial as the indicators provide many valuable trade signals.
Though there are some complicated ones, these indicators are, for the most part, easy to use. Even beginners can employ some of the strategies we explained here.
Moving Average indicators provides the trader with valuable insight, even in choppy market conditions. With it, the trader can set the appropriate stop-loss and take-profit values. They identify strategic points in the price chart in any market condition.
They are among the most famous indicators, and forex traders use them to trade different opportunities.
All it takes is to learn how to use these indicators, which is fairly easy. Anyone, including a novice trader, can put these MAs to the test to see if it works for them, following the strategies explained herein.
Using a demo or micro account to practice new strategies is a good approach to improving your trading skills. You can test the different MA approaches on these accounts, perfect your skills, and trade better. Not all strategies work for everyone. So it’s important to learn what works and stick with what you’re comfortable with.
Frequently Answered Questions
What is the best Moving Average in forex?
This depends on the traders’ goal and time frame. The best time periods for short term moving averages range from 5, 10, 15, to 20 days MA. For longer-term, 50, 100, and 200 days MAs are the best.
Are Moving Average strategies profitable?
Moving Average strategies are most profitable when it is higher. Traders combine Moving Average strategies with other indicators, such as RSI, CCI, Bollinger band, or Stochastic to get a more reliable signal.
Should I use SMA or EMA?
This depends on the traders’ preference. Draw both SMA and EMA lines on the price chart to determine which one you are more comfortable with. Note that when the price moves above the SMA or EMA, it means the market is in an uptrend. If it moves beneath, it is a downtrend market condition.
What MA is better? SMA or EMA?
The EMA emphasizes current data more and provides MAs based on the most recent prices. This makes it more reliable than the SMA. Forex traders prefer it to the Simple Moving Average.
What is the best EMA trading for day trading?
The most commonly used EMA for day traders are the 10-day and 20-day EMA timeframes. But longer term traders use bigger timeframes, such as 50-day or 100-day EMA.