Using Moving Averages To Identify Forex Trends
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Moving averages can be used in technical analysis, but they can be especially useful as a trend filter in trading analysis. This article discusses the concept of moving averages and provides an in-depth look at using the indicator to identify strong trends.
There is often a period of uncertainty in the moments that follow shortly after a bottom or uptrend, when the price starts to trade in the opposite direction. This can cause a lot of confusion in traders’ minds as it is not yet clear whether this is the start of a new trend or if the price is taking a breather before continuing in the direction of the previous trend. This is where moving averages can help.
For an in-depth look at moving averages in general and how to calculate them, read our article “Moving Average (MA) Explained for Traders”
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Consider the EUR/USD chart below. It is unclear whether these are the early stages of a new trend or inconsistent price action that could lead to further declines.
To better understand the trend, traders can include the 200-day simple moving average , also known as the 200 DMA. The 200 DMA is widely regarded as a strong trend filter because it requires a lot of data (price points) to calculate.
The 200 DMA is a Simple Moving Average (SMA), but traders who want to place more value on the recent price movement can look to the Exponential Moving Average (EMA).
The 200 DMA should be considered a trend filter, not an entry signal. Therefore, a potential entry should only be considered when the price is above the 200 DMA. The example below highlights this concept as the price has broken above the 200 DMA multiple times and then declined.
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Entry criteria are likely to vary between traders as it depends on the trader’s preferences. In this example, the upside was identified by trading above the 200 DMA (trend filter) with bounce support (200 DMA) and then breaking above the recent swing.
Therefore, look for price above the 200 DMA to sense the trend and then use technical analysis to spot possible entry levels. Finally, traders should adopt sound risk management techniques and implement a positive reward-to-risk ratio.
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When a trend is confirmed, it is important to manage the trade over time. Ideally, traders aim to stay in the trade as long as the trend continues. Therefore, more clarity is needed to assess whether the trend is still intact or a reversal is possible.
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The 200 DMA can be used as “dynamic support” during uptrends. The trend remains as long as the price continues above the 200 DMA.
A break below the 200 DMA could indicate that the trend is slowing or actually reversing. At this stage, traders can consider possible withdrawals if the limit has not been activated yet.
As with all indicators, there are conditions where moving averages thrive and others where they are less useful. The table below summarizes the advantages and disadvantages of using moving averages in trend trading:
Lag indicator (usually there is a lag period between the strong initial move and the period when the price is above the 200 DMA)
Importance Of Moving Averages In Trading
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By checking the box below, you confirm that you are not a resident of the United States. A forex trader can create a simple trading strategy to take advantage of trading opportunities using just a few moving averages (MAs) or related indicators. MAs are primarily used as trend indicators and also identify support and resistance levels. The two most common MAs are the Simple Moving Average (SMA), which is the average price over a number of time periods, and the Exponential Moving Average (EMA), which gives more weight to recent prices. Both of these form the basic structure of the forex trading strategies below.
This moving average trading strategy uses the EMA because this type of average is designed to react quickly to price changes. Here are the steps to the strategy.
Forex traders often use the short-term MA crossover and the long-term MA as the basis of their trading strategy. Play around with different MA lengths or timeframes to see which works best for you.
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Moving envelopes are percentage-based envelopes set above and below a moving average. The type of moving average that is set as the basis of envelopes does not matter, so forex traders can use simple, exponential or weighted MA.
Forex traders should try different percentages, time frames and currency pairs to understand how they can best use the envelope strategy. Most often, envelopes are seen on time frames of 10-100 days and use “bands” that are 1-10% away from the moving average on daily charts.
If day trading, envelopes will often be much less than 1%. In the one minute chart below, the MA length is 20 and the envelopes are 0.05%. Due to the volatility, the settings, especially the percentage, may need to be changed from day to day. Use setups that match the strategy below with daily price action.
Ideally, trade only when there is a large overall price movement. Most traders then only trade in that direction. If the price is rising, consider buying when the price approaches the moving average (MA) and starts to move up from it. In a strong downtrend, consider shorting when the price approaches the middle band and then starts to fall away from it.
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After a short trade, place a stop-loss one die above the recently formed swing high. After taking a long trade, place a stop-loss one die below the swing that just formed. Consider exiting when the price reaches the lower band of the short trade or the upper band of the long trade. Or set a target that is at least twice the risk. For example, if you are risking five points, set a target 10 points away from the entry.
The moving average bar can be used to create a basic forex trading strategy based on the slow transition of trend reversals. It can be used to reverse trends in either direction (up or down).
The moving average bar was created based on the belief that more is better when it comes to charting moving averages. A bar consists of a series of eight to 15 exponential moving averages (EMAs), ranging from very short-term to long-term averages, all on the same chart. The resulting bar of averages is intended to show the direction of the trend and the strength of the trend. The steeper angle of the moving averages and the greater distance between them, which causes the bar to spread out or widen, indicates a strong trend.
Traditional moving average bar buy or sell signals are the same type of crossover signals used with other moving average strategies. There are many crossovers, so the trader has to choose how many crossovers constitute a good trading signal.
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An alternative strategy can be used to place low-risk trade entries with high profit potential. The strategy described below aims to catch a decisive market breakout in either direction, which often occurs after the market has been trading in a tight and tight range for a long period of time.
The Moving Average Convergence Divergence (MACD) histogram shows the difference between two exponential moving averages (EMAs), the 26-period EMA and the 12-period EMA. In addition, the nine-period EMA is displayed as an overlay
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