The Complete Guide to Using Moving Averages in Forex Trading
Moving averages are the most popular trading indicator for technical analysis.
They can signal market and trend direction, act as support and resistance, provide a trading edge, and more...
On this page, you will learn everything you need to know about using moving averages when trading the Forex market.
"Moving averages are by far the most useful indicator. Are they lagging? Yes. Do they provide false signals? Yes. Are they still worth using? Yes! Show me a price action pattern, candlestick setup or technical indicator that is 100% reliable. You can't, as it doesn't exist! The key is to combine moving averages with other forms of analysis. Layering price action and indicators is key!"
A Beginners Guide to Moving Averages
When it comes to Forex technical analysis, many technical indicators can be used. The most common indicators include the Relative Strength Index (RSI), Volume, Bollinger Bands, and the MACD, to name a few. Moving averages are by far the most famous indicator, however. Most traders use them - independent retail traders and professional traders and market analysts.
What are moving averages?
As the name suggests, moving averages move. The moving average represents the market's closing price over a specified period.
For example, a moving average of fifty will calculate the average closing price of the last fifty candles, and a moving average set at twenty-five will calculate the average closing price of the last twenty-five candles.
These averages can be used in various ways, which I will cover below, but they are always used for the same purpose - to forecast direction.
What are the SMA and EMA moving averages?
The two most popular moving averages are the simple moving average (SMA) and the exponential moving average (EMA). The difference is that the EMA puts more weight on recent price data than older data; the SMA does not. In other words, the SMA traditionally calculates averages, whereas the EMA calculates the average with more emphasis on recent closing prices.
Which is better, the SMA or EMA?
Like most indicators and forms of market analysis, it's personal preference. There is not one particular moving average type that is better.
I personally use SMA's.
What do moving averages look like?
Averages are calculated, plotted on price charts, and joined to create a line or wave across a price chart. These waves are generally coloured and will look like this:
Moving Average Settings Explained
However, moving averages only have one variable, regardless of the moving average type: the moving average period or length.
A moving average period is the amount of candles the moving average uses in its closing price calculations. A period of ten uses the closing price of the last ten candles, whereas a period of two hundred uses the closing price of the previous two hundred candles.
Fast and slow moving averages
A shorter period makes a moving average "faster". It reacts quicker to recent price data and is generally closer to price. Faster moving averages can be more jumpy in how they are displayed.
A more extended period makes a moving average "slower, " meaning that the moving average does not react so quickly to recent price data and is generally further away from the price. Slower moving averages are generally more smooth in the way they look.
Below is an example that will be helpful. The black moving average has a period of two hundred. The green moving average has a period of twenty-five.
What are the best Moving Average Settings?
This is a common question that many traders ask. The first thing to mention is that no moving average setting will provide a 100% reliable and accurate indicator - that's impossible. The second thing to say is that no single setting is suitable for everyone - the way you trade and analyse the market and the strategies you use impact the moving average period and type you choose.
However, below are my recommendations:
Moving Averages for Swing Trading
If you watch Bloomberg or have seen professionals trade, you may have noticed three periods of moving averages that are commonly used: the 50, 100 and 200 period moving averages. These are the settings I use and recommend you use too. I use these moving averages on the weekly, daily, four-hourly, and one-hourly time-frames.
I use these moving averages for the following reasons:
It makes logical sense to watch and use what the professionals are watching and using. You want to be trading like them.
They work. These periods are more reliable than most others, especially regarding dynamic support and resistance (more on that later).
Moving Averages for Day Trading
Regarding day trading, moving average periods used by traders vary greatly.
Some day traders still use the periods recommended above. They analyse higher time frames with the 50, 100, and 200 moving average periods and day trade based on that information.
Day traders focusing on low time frames, such as the 1-minute, 5-minute, and 15-minute charts, tend to use the 7, 14, and 21-period moving averages.
Using Moving Averages to Forecast Forex
As mentioned previously, moving averages are the most popular trading indicator. I love them. They provide an edge and can be used in many helpful ways, including chart analysis, market entry, and exit.
Below are details on the most common ways moving averages can be used:
Forecasting Market Direction
Moving averages can be used for market direction - for confirming current downtrends, uptrends, and ranges.
The best way to use moving averages for market and trend direction is to have a faster and slower average on your price chart. I suggest a combination of the 50 SMA and 100 SMA or the 100 SMA and the 200 SMA.
When the slower-moving average is above the faster-moving average, i.e., the 100 above the 50, this can confirm a downtrend. These are referred to as bearish moving averages.
When the faster-moving average is above the slower-moving average, i.e., the 50 above the 100, this can confirm an uptrend. These are referred to as bullish moving averages.
When the moving averages cross frequently and move sideways, this can confirm market indecision or a market range:
Trend and market direction can also be confirmed by simply paying attention to the direction of a single moving average.
If a moving average moves steadily downward, price could be down-trending.
If it moves steadily upward, price could be up-trending.
If a moving average is moving sideways, this can signal market consolidation.
Forecasting a Change of Market Direction
When two moving averages (a faster and a slower one) cross, this can signal a change in market direction.
Some trading strategies are based on moving average crossovers.
When bullish moving averages cross and become bearish, this can signal a change of market direction from an uptrend to a downtrend.
When bearish moving averages cross and become bullish, this may signal a shift in market direction from a downtrend to an uptrend.
"Trading moving average signals by themselves will not make you a successful trader. No profitable trading strategy is based just on a technical indicator. Moving averages (and all indicators) should be used for confirmation of market analysis or as part of a trading strategy, not the sole reason to enter a trade"
Moving Average as Support and Resistance (dynamic support and resistance)
This is my favourite way to use moving averages.
Moving averages provide support and resistance. This is often referred to as dynamic support and resistance.
Dynamic support and resistance can be used for trade entry, exit, and market analysis. It can be a super addition to a Forex trading strategy.
The examples below illustrate moving averages acting as support and resistance. You'll see that when price reaches a moving average, it can reverse at the moving average, just like how price can reverse around horizontal or diagonal support and resistance.
Forex Trading Strategies using Moving Averages
Moving averages can be a significant part of any trading strategy. My trading strategies use moving averages to confirm market direction and provide support and resistance for adjusting my stop-losses.
Trading strategies often use moving averages in the following ways:
The Moving Average Crossover, i.e., for trend reversals
The Moving Average Pullback, i.e., as dynamic support and resistance on trend retracements
Moving Average Direction, i.e., for identifying trends and market indecision
Moving averages can help with any of the following as part of a trading strategy:
Take Profit Adjustment
Take Profit Placement