The Moving Average (MA) is a trend indicator. Like any other trend indicator, moving averages add to the actual chart. This is where the price action takes place. In this article we will go through the best moving average strategies in Forex.
Many trading platforms place an oscillator at the bottom of a chart, in a separate window. This is the visual difference between a trend indicator and an oscillator.
Moving averages are, like the name suggests, an average of previous prices. Depending on the period considered, they move faster if they consider a shorter period, like ten or twenty candles. Or they move more slowly when one hundred or more candles define the average.
Traders love moving averages because they have a tremendous visual impact on the state of the market. They can buy or sell in bullish or bearish markets thanks to moving averages.
What are Moving Averages in Forex?
Moving averages lag current prices. At any one moment, there are two values plotted on the screen:
- the actual price
- the MA value
The value of moving averages is different than the actual price. In a bullish trend, the MA is below the current price, while in a bearish trend, it is above.
Traders can use many types of moving averages. An exponential moving average (EMA), a simple moving average (SMA), and even moving averages that consider the volume traded in a financial product.
For example, consider the daily time frame of any currency pair. Go onto the trading platform and look for the trend indicators and select any MA from that list.
The MetaTrader 4 platform allows you to pick the type of moving average by selecting it from the pop-up window that appears. The image below shows the four options for moving averages, but that is not all. Different platforms have different options.
By selecting the SMA and using the settings from the previous example, we can plot the average on the chart. A moving average Forex indicator like this one shows a comparison between the current market price of an underlying security and the moving average value.
A simple moving average formula for understanding a market is to look where the price is and compare it with the MA. When the price is below the moving average, the market is bearish.
The same logic defines a bullish market when the price is above the moving average. While this sounds simple, keep in mind that in Forex trading simple things work best.
Calculating Moving Average
The formula to calculate a moving average is simplistic. However, this can differ, depending on the type of moving averages used.
A simple moving average calculator uses the following formula: it sums up the closing values of all the periods considered and divides the result by the period’s number. This is the simple moving average method, and it has slight differences in other types of moving averages.
To give a simple example, the exponential moving average (EMA) gives more importance to the current price levels, rather than the closing price of the candles that make the period. Between the SMA and the exponential one, the EMA is more accurate, as it doesn’t lag that much.
A moving average calculation is not mandatory on closing prices. It applies to various other prices, like opening ones, average ones during the day, and so on. The closing prices method is the most popular one and widely used.
Best Moving Averages for Day Trading
As mentioned above, the SMA and EMA are the most popular averages. It should come as no surprise that they are the base for any moving average trading strategy.
Simple Moving Average
I described the simple moving average (SMA) earlier. It averages the closing prices for the candles in the period considered.
If you have ever wondered how to calculate moving average levels, divide the average closing price to the periods considered. As the name suggests, it is a simple approach to finding the state of the market, but a reliable one.
Exponential Weighted Moving Average
An exponential weighted moving average puts more emphasis on the current price, rather than simply averaging the closing prices. It reduces the lag by applying more weight to recent prices.
While many don’t grasp the difference between the two, there is one, and it is significant. Below you have the EURUSD daily chart.
The two lines on the chart represent the 50-day SMA (the blue line) and the 50-day EMA (the red line). It is obvious now they are not the same and why the EMA isn’t lagging as much as the SMA.
The exponential moving average calculation results in the EMA being closer to the current price. For this reason, it is more accurate than the SMA.
The two moving averages are the base for many other technical indicators. Bollinger Bands is one of them.
Bollinger Bands uses an EMA. The Middle Bollinger Band (MBB) is usually an EMA.
Volume Weighted Moving Average
A volume weighted moving average (VWMA) is a simple moving average that considers the volume traded during that period. Is it more accurate than the exponential moving average formula?
The volume reflects supply and demand imbalances. Knowing when and where big players are buying or selling often means knowing when a new trend starts/ends.
The retail size of the Forex market is small. It barely represents around 6% of all daily transactions in the Forex market. To put this into perspective, consider that Forex trading is a 5.5 trillion dollar per day market.
The volume is critical in knowing when market participants, other than retail traders (commercial banks, central banks, Forex brokers, liquidity providers, etc.) buy or sell. It acts as an indicator that shows the real direction the market is heading.
There’s flow, though. The volume is irrelevant in Forex trading. Any volume indicator offered by a Forex broker shows only the volume traded at that broker.
It doesn’t represent the volume for the whole market. While it offers an educated guess, it is just a guess and not a certainty. The exponential moving average indicator values more.
Displaced Moving Average
This is a relatively new concept in technical analysis. A displaced moving average indicator (DMA) is nothing but a different simple moving average example.
Let me explain why. Traders found that multiple times prices slice through various SMAs as if there is no support or resistance. Then we see the price reacting from lower (in a bullish trend) or higher (in a bearish trend) levels.
To overcome this, traders are “cheating” a bit. They are using the same MA formula for the SMA, but shifting the outcome forward or backward in time.
The result is fascinating. Important support and resistance areas result using the same moving average, meaning only that a small trick influences the outcome.
Below you can see the GBPUSD daily chart. The blue line is the SMA(50), or the 50-day simple moving average. The red line is the DMA(50).
The displaced moving average formula is the same as the SMA one, but the outcome is shifted forward ten periods.
In this case, ten periods represent ten days. The historical differences between the two averages may end up creating a powerful displaced moving average MT4 indicator.
As always, there’s a trick. How much to shift backward or forward? What is the right period to use? Because of this, the results are random, and the exponential moving average formula prevails once again.
Moving Average Signals
Moving averages have different meanings for different markets because not all markets are the same. Financial products move differently based on the factors that influence them.
Consider the Forex and the stock market. They move in a correlated fashion only when shifts in the monetary policy affect them both. Golden and death crosses matter for the stock market, but not really for the Forex market.
A golden cross comes by plotting a smaller moving average (like the 50-day moving average, and a bigger one (one hundred or 200-day moving average). When the small moving average crosses the bigger one in a bullish direction, traders look to buy any dip.
A death cross is the opposite of a golden cross. It shows bearishness, as defined by the smaller moving average, crossing below the bigger one.
The AUDUSD daily chart below shows a recent golden cross. The SMA(50) moved above the SMA(200), and that signals a bullish environment.
Such a moving average crossover is a big deal for the stock market indices because the indices already show averaged data.
Let’s consider the Dow Jones in the United States (DJIA). It shows the changes in prices of the thirty companies that make the index.
Not all companies have the same weight. Some weigh more than others, but the DJIA shows the median or the average result when plotting a value on a chart. As a result, a golden or death cross has more value for the DJIA or any other stock index than on any single financial product.
A moving average’s forecasting power does not only come from a golden or death crosses. A cross between two moving averages represents the most popular moving average strategy. It doesn’t mean it is the most effective one.
A Forex moving average crossover strategy signals future support and resistance levels because traders buy after a golden cross and sell after a death one. Especially relevant is the period the moving average considers.
As a rule of thumb, the bigger the period, the stronger the support and resistance level is. Hence, many traders sell a spike into SMA(200) for the simple reason that rejection might appear.
Moreover, when the MA appears on a bigger time frame, such as the daily, weekly, or monthly ones, the support and resistance levels can’t be easily broken. In this case traders expect price hesitation.
Moving Average Trading Strategies
Many traders say that the best moving average for day trading is the EMA. It eliminates most of the lag and is more accurate. Hence, it is the favored choice among traders.
We should emphasize here again what EMA is and why it is so important in technical analysis:
- It puts more weight on current or recent prices, rather than simply averaging levels,
- As a result, it is closer to the price, showing dynamic support and resistance levels, not static ones.
Trading the “perfect order” between different moving averages represents one of the most effective Forex moving average strategy. The setup is simple: plot multiple moving averages on the same chart to spot an ongoing trend.
A perfect order for the moving averages implies a strong trend. If it follows a golden cross (the 50-day moving average crossing above the 200-day moving one), the trend is bullish, and traders will look to buy dips.
Lagging moving averages allow traders to buy a dip in a support area, or to sell a spike in a resistance one. The smaller the lag, the more powerful the setup. Hence, traders prefer exponential moving averages as they reduce the lag.
The start of 2017 saw the AUDUSD pair engaging in a strong trend. All eyes were on the golden cross and the perfect order to be in place.
This example contains four exponential moving averages: EMA (200), (100), (50), and (20). It goes without saying that the closest one to the price is the lowest MA.
Because a golden cross formed and right after it the EMA’s aligned in perfect order (there is no cross between any of the plotted EMA), this is a sign of a strong bullish trend. Therefore, traders look to buy dips.
Any dip into the bigger EMAs show signals to go long. Also, the bigger the EMA, the stronger the support level. This way the volume traded may be different; bigger volumes being favored when the price is reaching the higher moving averages.
The example above shows four distinct situations where the EMA(50) acted as a strong support level. The trend was so strong that prices weren’t able to reach the EMA(100) or lower.
To spot a trend reversal, all eyes should be on the lowest EMA. In our case, the EMA(20). When it is crossing below the EMA(50), it shows that the general trend is starting to weaken, so bulls should protect profits.
Trailing stop orders, placing pending protective orders – such crosses lead to different money management techniques. The support and resistance role of a moving average setup is the popular result of any moving average wiki search.
It doesn’t mean it is the perfect strategy. When calculating moving average strategies performances, better results appear if moving averages are used together with other indicators. The RSI (Relative Strength Index) is one of them.
Adding an oscillator to such a strategy results in the best moving average strategy for intraday trading. The following setup appears on the EURUSD hourly chart below:
- EMA(50) and EMA(200)
First, one should wait for either a golden or a death cross to form. In this case, a golden cross forms the moment the EMA(50) moves above the EMA(100).
Second, the RSI shows overbought and oversold levels. When the RSI moves to the 30 area, buyers step in. The opposite is true as well: the 70 level is the perfect sell.
It is a great way to use the oversold areas with the RSI as the moving averages are pointing to a general bullish trend. By the time RSI gives the entry, a nice long trade is placed with a high-probability to be a profitable one.
To sum up, moving averages are powerful trend indicators. Out of all the moving averages presented here, one stands out of the crowd: the EMA.
The other ones aren’t useless. Depending on the strategy used, they may have an important role in the decision-making process.
A disciplined approach to trading results is a good strategy. Also, the best parts of a technical indicator make a strategy profitable. However, one should not rely only on technical analysis when trading the Forex market.
Super Smoother (SS) Indicator
The Super Smoother is not an actual moving average. It is a separate indicator that looks like an MA and has nearly the same functions. However, the Super Smoother is designed to remove Aliasing Noise. This means that the SS in many cases will have less lag than the other Moving Averages.
The ForexBoat Academy has a special webinar on why Super Smoother is better than the moving average, and I suggest you take a look at it. It will show you why Super Smoother beats the regular MA with removing noise by considering the frequency of the signal.
The webinar is usually part of a paid subscription, but this time, you have the opportunity to get it cost-free. Just add your details below and you will be able to see the webinar for FREE.
If you are into moving average trading, I strongly recommend you go through the Super Smoother VS Moving Average webinar. The lecture will also give you a hint on how to modify the code of your Super Smoother for better results.
Trading is a game of probabilities. If traders understand that there is no holy grail to Forex trading, then they are on the right track.
Hard work and discipline are key to profitable trading. Technical strategies result in great profits only if they are followed and traded accordingly.
Most traders fail to follow their own strategy. Emotions take control of the decision-making process and the next thing you know, the account is gone.
Moving average strategies like the ones described here are great for the following reasons:
- They are visible, in the sense that it is not possible to miss a signal.
- They work most of the time.
- Traders end up on the right side of the market.
Together with a sound money management system based on realistic risk-reward ratios, traders may find that being profitable in Forex trading is more than a dream. It can become reality.
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