Moving averages are a simple tool that any forex trader should use and here we will look at how to use them correctly in your forex trading strategy for bigger profits.
Let's first look at what they are the logic behind them and the best time periods to use.
1. Moving Averages Aims and Definitions
Moving averages come in various forms, but they all have the same aim:
To help traders identify trends smoothing out the day-to-day price fluctuations and show the average price over a set period time.
The calculation is simple:
The closing price is simply added up and divided by the period of the moving average.
2. The Logic
Prices tend to rise slowly over the long term and short term extreme price spikes ten to be a short term reaction caused by the greed and fear of the participants. These price spikes never last long and prices return to the longer term average.
3. The Best Averages to Use
Moving averages are useless in short term time frames but very useful in longer time frames after years of trading these are the moving averages we find most effective.
The 40 day moving average
Can be used for identifying longer term trends and trailing stops can then be placed behind this level.
18 - 20 day moving averages
Can be used for getting into existing trends - this area in a strong pull trend is the ideal place to look to enter new positions.
Confirmation
You do not simply use a moving average to enter a position on a dip like many traders do this is hoping or guessing and you need to remember the moving average is giving you an idea of value and the trend and should not be used in isolation.
When see prices dip to a moving average or break one and you want to take a trading signal, make sure you confirm your trading signal with momentum indicators.
We have discussed this in our other articles so look them up.
Moving averages are a simple yet effective way for forex traders to use and if used correctly and you use the right time periods you will find them an essential trading indicator you can use in your forex trading strategy for bigger profits.
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