Moving average is one of the simplest tools among the most used technical indicators. A large majority of traders who are using technical analysis techniques, use moving averages for identifying the directions of a trend or finding resistance and support levels. Also, moving averages are used while calculating some indicators like MACD, Bollinger Bands and Ichimoku. What is moving average? How are moving averages calculated? What are the types of moving averages? I will explain how to use moving averages in forex trading in this article.
There are 3 types of moving averages. Simple Moving Average, Linear Weighted Moving Average, Smoothed Moving Average and Exponential Moving Average. The most used and simplest type of moving average is simple moving average. Moving averages generally used over 10, 50, 100 and 200 time periods. However, there are no predetermined time periods. You need to try moving averages in different time periods and find the best one for your trading strategy.
How to Calculate Moving Average?
Simple moving averages are calculated by dividing the total value of the closing price by the time interval. For example, if you are using 50-period simple moving average on a 1-day chart, you should add up the closing prices for the last 50 days and divide this number by 50.
Using Moving Averages with Support & Resistance
You can use moving averages to determine support and resistance levels. In EURUSD daily chart below, you can see that 200-day moving average has worked as a support level several times.
Moving averages also may help you to identify the directions of a trend. For example, you can see that prices are moving below the 100-day & 200-day moving averages. That means downtrend continues. If the price moves above the moving average it could be a buy signal. But you should always watch out for fakeouts.
Golden Cross & Death Cross
“Golden Cross” is a bullish technical formation that is based on moving averages. According to this formation, if short-term moving average rises above long-term moving average, then it is a “buy” signal.
As you can see in the chart below, the prices continued to rise when the 50-day moving average rises above the 200-day moving average.
As you can guess, “Death Cross” is a bearish technical formation. This time short-term moving average falls below long-term moving average and it generates a “sell” signal.
Moving Averages are very useful and helpful technical analysis tools used by traders all around the world. However, I should say that trading barely based on moving averages may not bring the profits that one might expect. In technical analysis perspective, it makes much more sense if one trader uses few technical indicators and trade once those indicate the same signal in terms of direction.