What Are Moving Averages?
A moving average is simply a way to smooth out price action over time. By “moving average”, Like every indicator,
a moving average indicator is used to help us forecast future prices. By looking at the slope of the moving average,
you can better determine the potential direction of market prices.
Let’s say that USD/JPY has been in a downtrend, but a news report comes out causing it to surge higher.
You see that the price is now above the moving average. You think to yourself:
“Hmmm… It looks like this pair is about to shift direction. Time to buy this sucker!”
So you do just that. You buy a billion units cause you’re confident that USD/JPY is going to go up.
Bammm! You get faked out! As it turns out, traders just reacted to the news but the trend continued and price kept heading lower!
What some traders do – and what we suggest you do as well – is that they plot a couple of moving averages on their charts instead of just one. This gives them a clearer signal of whether the pair is trending up or down depending on the order of the moving averages.
Let us explain.
In an uptrend, the “faster” moving average should be above the “slower” moving average and for a downtrend, vice versa. For example, let’s say we have two MAs: the 10-period MA and the 20-period MA. On your chart, it would look like this:
Above is a daily chart of USD/JPY. Throughout the uptrend, the 10 SMA is above the 20 SMA. As you can see, you can use moving averages to help show whether a pair is trending up or down. Combining this with your knowledge on trend lines, this can help you decide whether to go long or short a currency.
You can also try putting more than two moving averages on your chart. then you can tell whether the pair is in an uptrend or in a downtrend.
How to Use Moving Average Crossovers to Enter Trades
By now, you know how to determine the trend by plotting on some moving averages on your charts.
You should also know that moving averages can help you determine when a trend is about to end and reverse. All you have to do is plop on a couple of moving averages on your chart, and wait for a crossover.
If the moving averages cross over one another, it could signal that the trend is about to change soon, thereby giving you the chance to get a better entry. By having a better entry, you have the chance to bag mo’ PROFITs!