Introduction
Regular readers of this site will know that I am a big fan of moving averages, so much so that I will nearly always include them on my price charts, regardless of whether I am trading stocks or forex.
As I explained in a previous article that discusses the many different types of moving averages, I am a big fan of the exponential moving average in particular because this seems to reflect the latest price movements fairly well and is used by a lot of other traders.
However in this article I want to discuss why moving averages are so useful, regardless of which one you prefer to use, and how they can help you to improve your trading results.
Crossover Trades
One of the simplest trading strategies that you can use is one where a shorter-term moving average crosses a longer-term moving average because this is generally a good indicator of a change in trend.
I have always found that you can get fairly good results when the 5-period moving average crosses through the 20-period moving average, as discussed here, providing you are trading in the same direction as the prevailing long-term trend, but you can of course experiment with different settings to find a strategy that works for you.
Pre-Breakout Signals
Breakout trading can be one of the most profitable ways to trade the foreign currency markets because when a pair trades within a narrow trading range for a sustained period of time with no clear direction, it will eventually break out of this range and move strongly upwards or downwards.
Therefore moving averages can be very useful in this regard because when you add multiple moving averages to your charts and find that they are all very close to each other, this signals a period of indecision and often occurs before a big breakout.
I suggest adding the 20, 50, 100 and 200-period moving averages to your price charts, waiting for some confluence, plotting some trendlines highlighting the highs and lows of this sideways trading range and then trading any subsequent breakouts.
Price Targets
When I trade stocks, I also like to use the longer-term moving averages as natural price targets. That’s because I will typically buy good quality stocks when they are trading well below the 20, 50, 100 and 200-day exponential moving averages, and sell when the price bounces back and hits the 100 or 200-day EMA because these often act as resistance.
I intend to use this exit strategy with my new eToro trading account for some of my short and medium-term trades, but you can of course use these long-term moving averages as price targets when trading forex pairs or any other markets.
To give you an example, the chart below shows the price of the GBP/USD bouncing back to hit both the EMA (100) and the EMA (200) a few months ago:
Final Thoughts
The point is that moving average indicators are some of the most useful technical indicators that you can use because they can be used in many different ways, as I have hopefully demonstrated in this article.
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