Today we finish our two part series on moving averages with “Moving Averages Part II.”Yeah I know some of you don’t want this series to end, but all good things must come to an end. Just to refresh your memory we started off with We’re Moving Averages Part I. We defined moving averages and took a look at the two main averages tools – Simple Moving Averages a(SMA) and Exponential Moving Averages(SMA).
Today we’re going to close the show by learning how to use moving averages to find trends.We’ll then find out how to use moving average crossovers to enter trades, and lastly, how to use moving averages as dynamic support and resistance levels.
So let’s start off with:
Use Moving Averages To Find Trends
It’s possible to use moving averages to find trends. If anything,moving averages help you determine the trend. You can start by plotting a single moving average on the chart. But remember this: When price stays above the moving average it means that price is in an uptrend.And when such a scenario unfolds,,it’s your signal to enter a trade. Let’s take a look at an illustration of this scenario.
As you can see, the blue line represents the moving average. And if the price is higher than the moving average. It’s time to put in a buy trade and laugh all the way the back.
get hairy sometimes. Let’s say USD/JPY goes into a downtrend.But a news report causes the price to surge even higher. You then discover that the price is now above the moving average. So you say to yourself. “Hmmm…How about I put in a buy trade now that the market is hot”? So you put in a buy trade with the confidence of a soothsayer that USD/JPY will surge further upwards. Suddenly, out of no where you get faked out.(Remember the fakey pattern?) Instead, the trend goes downward, and the price keeps getting lower, leaving you holding the bag.. Let me show two illustrations of this scenario.
The USD starts a downward trend. Then all of a sudden,an uptrend starts taking shape.Of course you gets sucked into believing it’s time to make a buy trade.
As you can see , you get fooled by the market as it continues with its downward slope,leaving you holding the bag.
The moral of the story is that you plot not one, but two moving averages. Why? because with two averages you get a clearer signal of whether the pair is trending up or down, depending on the order of the averages. One thing you need to understand is that in an uptrend the faster moving average should be above the slower moving average.It’s vice-versa for the downtrend. Let’s take a look at a 10 period MA and 20 period MA.
As you can see an uptrend is developing nicely here with the 10 SMA above 20 SMA. With two trend lines,you should be able to tell whether a currency pair is trending up or down. Assuming you’ve finally figured out how use moving averages,you can combine that with your knowledge of trading trends to decide whether to go long or short on a currency.
If you want to get adventurous, you can put more than two lines on your chart. Just make sure the lines are in order of importance(Fastest to slowest in an uptrend, and slowest to fastest in a downtrend.This way you can tell whether the currency is in an uptrend or downtrend.
By the way if you’re still at sea about trading trends, go back to my post Trade Trends With Price Action Analysis
Use Moving Average Crossovers to Enter Trades
It’s also possible to use moving average crossovers to enter trades. No, I’m not referring to Kobe Bryant’s deadly crossovers. I’m referring to moving averages crossing over each other. How do you discern these signals?Just plot a couple of moving averages on your chart, and hang tight for a cross over. If one moving average crosses the either,it’s a signal that a trend is about to change. This trend switch is your queue to make a solid entry. and a chance to cash in big.
Let’s take another look at the USD/JPY daily chart to explain moving average crossover trading.
Between April-July, the pair seems to be in a good place trend-wise. Then it reaches its peak at 124 before before making the downward spiral. By mid-July, the 10 MA crosses below the 20 MA. And what happens next? A nice downtrend takes shape. This downtrend takes shape because of the two moving averages crossing each other.
One thing you need to understand is that yes, a crossover system works wonders in a trending environment. But it flames out in a consolidation environment;when prices start ranging. And when that happens it make take a while before you spot another trend.
Using Moving Averages As Dynamic Support and Resistance Levels
It’s even more possible to use moving averages as dynamic support and resistance levels. If you’re wondering whether you’ve come across this term before, yes you have.You saw it in my Something Called Confluence post. Dynamic support/resistance levels are not like their static horizontals support/resistance brethren. Dynamic support/resistance levels are constantly changing faces depending on current price action.
A lot of forex traders view moving averages as key support or resistance. These traders buy when price dips and tests. the moving average. Or they buy when price rises and touches the moving average. Let’s take a look at the 15 minute chart of GBP/USD for illustration
It seems 50 EMA is holding the line quite well.Whenever the price approached 50 EMA,and tested its mettle, it hit right back and forced price to bounce back down.
But there are times price will elude EMA before reversing in the direction of the trend. And there are also occasions when price will just bamboozle through EMA all together. What you could do in such a scenario is plot two moving averages on the charts You buy or sell only when price is in the space in between the moving averages. This area is also as the zone.
Let’s take another look at this same 15 minute chart using 10 and 20 EMA’s
Fromt he look of things, price drifted past price few times, but start heading downwards afterwards. The whole point of this strategy is that just like hrizontal support/resistance levels, the dynamic version should be viewed as zones of interest.Think of the area between the moving averages as zones of support or resistance.
Break Through Dynamic Support and Resistance.
Just like any barrier, you have to break through dynamic support and resistance. As you already know,moving averages at as support and resistance. But they can be brittle at times-causing them to break just like any other support/resistance level.
The 50 EMA on the GB/USD’s 15 minute chart should clarify things
It looks like it held really well! Every time price approached 50 EMA and tested it, it acted as resistance and price bounced back down.
There are also times when price just bamboozles past EMA altogether. What you do in such a scenario? Plot two moving averages, and only buy or sell once price is in the middle of the space between the two moving averages. You could call this area “the zone.”
Well,that’s a wrap for”We’re Moving Averages Part II.” We learnt that moving averages can be very useful tools in price action analysis. They help forecast prices in both present and future.The trick is trying to choose which moving average to use for your analysis.I hope you’ve had fun as much as I have. I know I have.
Til next time take care.
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