Forex Trading: How To Make The Most (Profit) Out Of Moving Averages
Technical analysis is invariably one of the most popular forex trading strategies together with fundamental analysis. Within technical analysis there are countless strategies that professional traders use. Just to name a couple, we could mention Stochastic Oscillators and Fibonacci Retracements. However, perhaps the most used method by far is perhaps moving averages. If you want to be profitable at trading forex, you need to understand moving averages (even if you decide not to use them in the end). 😉
Moving averages are probably the simplest mathematical formula used in technical analysis. Some may argue it is also the most effective.
You will understand why it’s one of the simplest in a second. First you need to determine the time horizon over which you want to run your analysis. This can be one week or 8 straight or any other time period that you select. If you do a quick Google search you will see how much debate there is on what is the “best” timeframe to be running technical analysis. You then get the closing price for each period that you selected. Then take the sum of these closing prices and divide it by the number of time points. This is your moving average!
Forex traders will look at many different averages based on different time periods indeed. The most frequent averages are the 10, 20, 50, 100, and 200 days moving averages (or MAs). You then assess the current price of the currency in relation to its moving average(s). If the price moves closer to the average then it is said to be weakening. If the price moves toward the trend then it is considered to be growing stronger.
As you perform this analysis you will surely plot the different moving averages versus the historical price chart. Shorter periods naturally show more volatility than longer periods. When the 2 moving average lines cross they can signal a turn in the market (for example the 10 and 50 days moving averages). This is one of the simplest trading signals used in forex trading. This is how I started. 😉 If the 10 day moving average crosses and goes above the 50 day moving average, this can be considered a bullish signal. And vice versa.
There are then two main methods used to calculate the average. These are simple moving average and exponential moving average. With a simple moving average, the same weight is applied to all prices. You will find most traders use this. Exponential moving averages apply different (exponential) weights to the different prices with the most recent prices given a higher weight. In other words, they multiply each price with an exponential weighting factor.
Like most technical analysis the key is in devising a set of mechanical rules and back-testing their profitability. Moving averages is usually where many traders start…and where many end up!