Moving average indicators: using them to trade

Before reading this lesson, you should have previously read through:

The moving average is one of the most commonly used indicators and they are generally used for two things: determining the market conditions, and entering and exiting a trade.

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What is a moving average indicator?

A moving average is a display of the average price of an instrument over a specific period of time. It is displayed as a line on the chart. The moving average line is constructed by taking the average price over a specific number of periods. Each average price is then plotted on the chart; usually it is the closing price of each candle that is used.

A moving average is an indicator that displays the average price of an instrument over a specific period of time.

Let's consider a 20 period moving average on a five minute chart. Each point of the moving average is calculated from the average closing price of the last 20 five minute candles. As each five minute candle forms, the moving average will continue to plot the average closing price of the most recent 20 periods. The result is a continuous line, as seen below.

Simple moving average 20

number_1 - Simple moving average over 20 periods

A moving average is not always 20 periods, it is customisable, and so you can choose whichever period you would like.

For example, the chart below is displaying a 200 period moving average, so the calculation is based on the previous 200 periods from the current candle.

Simple moving average 200

number_1 - Simple moving average over 200 periods

The moving average is used to smooth the price action by producing a single line that makes it easier for traders to interpret market information, such as current trend direction.

Looking at the chart below, the trend direction and strength can be identified by observing the slope and the angle of a moving average. If the moving average is very steep then the price is in a strong trend.

Simple moving average 20 uptrend

number_1 - Steep angle to the upside denoting a strong bullish trend
number_2 - Flat angle in a range denoting a weak bullish trend
number_3 - Steep angle to the upside denoting a strong bullish trend

A trader can also use a moving average to make decisions as to which way to trade by observing whether the price is above or below a moving average.

If the price is above a moving average, it is higher than the recent price averages and thus it stands to reason that the price is moving up. Similarly, if the price is trading below a moving average it can be interpreted as the price moving down.

Typically, if price is above the moving average, it stands to reason that price is moving up. If price is below the moving average, it stands to reason that the price is moving down.

Take note that this is subjective, because any moving average is relative to the period for which you are observing the trend, and further moving averages on the chart must also be taken into consideration.

Take, for example, the information in the chart below. If the price is trading above a 20 period moving average, you might determine that the price is currently trending to the upside. However, the price could also be trading below the 200 period moving average, meaning the price is in an overall long term downtrend.

Simple moving average 20 and 200 uptrend

number_1 - 20 period moving average denotes short term uptrend
number_2 - 200 period moving average denotes that we are still in a long term downtrend

A trader can use these moving averages to not only determine what trend the price is currently in for the shorter term, but to also determine the overall longer term trend.

Using multiple moving averages to define a clear trend

By using multiple moving averages, a trader can determine a clear downtrend or uptrend.

Using multiple moving averages means that you can determine clear uptrends and downtrends.
This is because when the market is clearly trending, the moving averages will move into the order of the periods away from the price. The chart below demonstrates that when the price is in a downtrend, the 10 period moving average is closest to the price, the 20 period is the next closest, and so on. With the moving averages in order, the downtrend is clearer to see.

4 moving averages

number_1 - 200 period moving average
number_2 - 50 period moving average
number_3 - 20 period moving average
number_4 - 10 period moving average

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Choosing the period

There are no specific rules when choosing the number of periods a trader should apply when using a moving average indicator, the choice is purely down to the individual.

The shorter the period of the moving average, the more quickly it will change with price, but will provide less reliable signals than a longer period moving average. Similarly, a longer period moving average will provide more reliable signals, but will react to price changes much more slowly.

The shorter the period of a moving average, the more quickly it will change, but it will provide less reliable signals. The longer the period, the more reliable the signal, but prices changes much more slowly.

For example, the 10 period moving average takes into account the last 10 periods and will therefore react to the change in price direction very quickly. The downside to this is that the trader may often receive false signals in the change of the trend because short term spikes in price can occur.

On the other end, the 200 period moving average takes longer to react and produces fewer false signals. The downside is that because the reaction is slower, the signals that are produced are much less frequent.

In the chart below we can see how the 10 period moving average (purple) changes direction in line much more quickly with the change in price, while the 200 period moving average (red) does not.

fast below slow MA

number_1 - 200 period moving average has not yet registered the new move
number_2 - 10 period moving average is in a downtrend

Different moving average types

You do not need to be concerned with the actual calculation of the different types of moving averages; almost every charting package will calculate this automatically and you only use the visual lines on the charts.

There are four types of moving averages:

  • Simple
  • Exponential
  • Linear weighted
  • Smooth weighted

The fundamental difference between these types of moving averages is how they are calculated. Due to this, they appear differently on the price chart.

The simple moving average uses each period with equal weighting in its calculations. The exponential, linear and smooth weighted averages emphasise the most recent periods in the calculations. Consider the 50 period moving average on the following chart in conjunction with the different moving average types, you can see the difference in appearance.

different types of moving averages

number_1 - Linear weighted moving average
number_2 - Exponential moving average
number_3 - Simple moving average
number_4 - Smoothed moving average

Using moving averages as support and resistance

When price comes into contact with the moving average on the price chart, if it is below, the moving average can act as resistance; if it is above, it can act as support.

Moving average indicators can also be used as support or resistance for possible entry or exit points in the markets. What this actually means is that when the price comes into contact with the moving average on the price chart, traders watching the charts will then enter orders to either buy or sell. This essentially works in the same way as a horizontal support or resistance line.

If the price is below the moving average, then the moving average will act as resistance; if the price is above the moving average, it will act as support.

Moving averages are dynamic support and resistance because they change as the price moves.

MA as resistance

number_1 - Simple moving average
number_2 - Price action uses moving average as resistance

Moving average crossovers

Moving average crossovers can be used to determine when a trend has changed direction. The concept uses two moving averages of different periods to show the short term and the longer term trend in the price.

When a short term moving average crosses below to above a long term moving average, this can signal that the trend is changing direction to the upside. Likewise, if a short term moving average crosses above to below a long term moving average, this can signal a change to the downside.

When the shorter term moving average and the longer term moving average cross each other, this can show that the trend has started to change direction. When observed, traders can use this to appropriately time entries and exits from the market.

The chart below shows what it looks like when the trend changes from a downtrend to an uptrend. We can identify it as such because the fast moving average, which was below the slow moving average, crossed the slow moving average. When this happened, a clear trend change to the upside in the price action could be seen.

MA cross over

number_1 - Slow moving average
number_2 - Fast moving average
number_3 - Fast moving average crosses over the slow moving average

Summary

So far, you have learned that ...

  • ... a moving average is the average price of a currency pair calculated from the closing price of a specific amount of periods.
  • ... a moving average indicator can be used to determine the trend.
  • ... there are four main types of moving averages: simple, exponential, linear weighted and smoothed.
  • ... there is a trade-off between the reliability of a moving average and how quickly it will react to the change in trend.
  • ... moving average indicators can be used as support and resistance levels.
  • ... moving average crossovers can be used to determine a change in the trend.

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  • Hw can set the fast and slow moving average
  • Hi egbewola,
    Go in Mt4 platform on Insert button on top > select indicator > Trend >Moving average. You can choose the Period (the lower the value the faster it is) and calculating Method. You get the hang of it once you try and play around a little with it. Regards.
    Hindsighthero
  • Hi dodibonvis,

    Not sure what your comment means - could you stick to english on the forum (apart from indonesia group) so we can all understand and help you smile

    Thanks
    Emma
  • If I am to use 2 MA's . One short and one longer, what are the periods that is generally recommended? Is it 10 & 20?
  • Hi vichoos,
    Short term is somewhere : 10-30
    Medium term: 30-80
    long term: 100-200

    Another rule of thumb: it's good to have a ratio of ca. 2-4:1 between these period classes. E. g.: 15, 50, 200; 20, 50, 100.
    But ultimately it is your choice depending on whatever characteristic you would like to catch with these gauges.
    Regards.
    Peter
  • @ vichooos
    I personally like to use what most people use....I like to look at the same thing as the people who have to power (money) to move the markets are looking at. I personally use 3 MAs the 100 period and 200 period MAs and then another one depending on the currency pair. They are Simple Moving Averages.

    When CNBC, Bloomberg, the WSJ etc. talk technicals, they always mention the 200, 50, and 100 period Moving Averages.

    The following are some other Moving Averages to keep in mind for currencies because they are followed by many:

    EUR/USD 55 period Simple MA
    USD/JPY 10 period Simple MA
    AUS/USD 20 period Simple MA
    Equities 50 & 200 period Simple MA
  • Hi with MAs is it best to stick with the longer term charts such as 1h(+) rather then short term like the 5m? Sometimes when I flick between charts the 5m is indicating an almost different trend to the hour chart, I understand why but wondered if the 5m in MA is not so useful. thanks d
  • Hi Dorian,
    Chart is a chart and EMAs and other indicators mean the same on all time frames. If you have a 1 hour uptrend but 5 minute EMAs are bearish that might mean it's not yet time to buy. You might decide that you ignore EMAs on your entry time frame to enable you to be a bit more aggressive but price still behaves around them pretty much similar like on the 1H, D, or W chart. Regards.
    Peter
  • Good Afternoon All, got a further question RE Moving Averages, so in this morning’s case (GBPvsUSD) the 21 day average crossed from below the 200 day average and I interpret this signal an uptrend. It clearly crossed through the candle and until I left to get to work I was in good profit. From experience should I leave a few candles to form before jumping in to the trade? and If so what is a practical no. to let form up. (Remembering my Fractal Strategy.) As always thanks and kind regards D
  • Hi Dorian,
    Is it the 1H chart where they crossed? In general a shorter term MA crossing above the longer term one means bullishness. But i always take a look at the bigger picture. On 4H we just broke a downtrend but no new high has been posted, so there's a high likelyhood that if you buy at current levels you buy the top:
    http://prntscr.com/2kyvi9

    Besides here on 4H 21 MA is below the 200 so this time frame is bearish in that sense then.

    Look at the chart below. It is the 1H version of the one above. I marked the areas where the 'bullish cross' resulted in fake outs.
    http://prntscr.com/2kywyu

    Why did the MAs give false signal? Because the bigger picture shows that it was a downtrend and in these cases maybe fading the cross is a better idea. Try some filters to eliminate these traps. I would recommend Multiple Time Frame Analysis and Support and Resistnace.

    With kind regards.
    Peter
  • Are there any recommendations on using MAs in the beginner strategy.

    For example using a 20 and 50 Period MA on the 30 minute chart and using that as another method of confirmng the trend as well as using fractals.

    Or would it be possible to use MAs on the 5 min chart in relation to the beginner strategy

    Regards Jordan
  • Hi Jordan,
    I think moving averages are really useful tools. Some use it to determine trends taking slope and crossovers into account or they can be used to create confluence with other horizontal zones determined by either fibs or visual S&R lines. For example one can filter signals by taking only those fractal breaks on 5 min that not only fulfill the basic beginner strategy criteria but also emerge from an MA on the 30m time frame thus adding confluence and importance to that level and potential reversal. What do you think?
    Regards.
    Peter
  • Yea that makes a lot of sense to me,

    I still haven't covered the lessons on SARs or Fibs but i am making use of my easter break trying to soak up as much knowledge on Tradimo as i can.

    So thank you very much for your quick responses on what are probably very basic / trivial questions. And thanks for all the amazing content on this great site.

    jordan smile
  • Since you are gold member you can also participate in Live trading room classes and have access to the whole coaching archives for free. Don't forget to check them out:
    http://en.tradimo.com/coaching/access-live-trading-classroom/

    smile
  • Hi,
    I have a question regarding membership. How can i become a gold, or silver member ? and how this works ?


    Thank you
  • Hi Martin,
    The status system doesn't exists anymore, all content that used to be status restricted is now free to anyone who creates a tradimo account.
    Regards.
    Peter

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