Moving Averages In FX Trading Room

Hello Forex traders,

If a Forex trader were to ask our trading room: “can you explain your strategy in 1 sentence, and if so how?”, then our answer would be: “yes, our trading room strategy is focused on trading with the trend break outs after sizeable corrections using trend lines as the main measurement tool.”

Obviously, we have many more rules and guidelines for our strategy. But ultimately this is the core message and point of the strategy. And all strategies should have this simplicity at its heart, otherwise the Forex strategy is probably too complex to implement.

Therefore, on the charts of the trading room, we keep things simple, because having a complicated approach in fact just complicates the entire process. In our trading room you would always see the following on our charts:

1)      a few trend lines;

2)      1 oscillator;

3)      and the fractal indicator (to easily spot support and resistance).

Then occasionally we would add a Fibonacci level and a trend channel. Besides this, there is one more tool we have on the chart: the moving average. This indictor is not a primary element of our decision making process, but it is used for informational purposes and it is an aid when discretionary decisions are made. Here is a list how the trading room uses those moving averages from a practical point of view.

Here are some great articles that dive into explaining moving averages in more detail.

1)      Moving averages 

2)      SMA’s 

3)      EMA’s 

4)      Using moving averages to trade Forex

TREND DEFINITION

The trading room uses 2 EMA’s on the charts. One is an intermediate period EMA, and the other is a long-term EMA.

1)      For the intermediate EMA anything between 20 and 50 can be used. In some cases even 2 intermediate EMA’s can be used like 20 & 40 or 30 & 50 to create a “river”.

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2)      For the long-term EMA anything between 100 and 200 can be used.

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The intermediate EMA is the primary indicator for trend identification. Obviously if price action has a clear history of either below or above the intermediate EMA, then the currency pair is in a strong trend. When price breaks above this intermediate moving average, then there is a potential for either a larger retracement or reversal.

The trading room uses this intermediate moving average together with trend channels and classical higher highs and higher lows and lower highs and lower lows for trend definition on primarily the 4 hour chart.

The trend channel has the advantage of showing both potential support and resistance in trend, which the moving average can’t (only support in uptrend or resistance in downtrend). The advantage of the moving average is that it is more flexible than a trend channel which requires 3 hits to be valid (and sometimes there are no 3 hits).

SUPPORT AND RESISTANCE

The moving averages always are specifically useful for support and resistance purposes within a trend but not in a range.

1)      TREND:

Once the market is clearly trending then any pull back towards the intermediate and long-term moving averages has a decent statistical probability of being a pullback / retracement. However, you do need to check the analysis on 1 time frame higher for tops or bottoms and could stop the trend from continuing. In that scenario the currency might not be retracing but reversing.

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2)      RANGE:
In a range the market will not use the moving averages as a support or resistance. Instead the moving averages will become a mean and the moving averages will often enough be in the center of the range.

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ANGLE

The angle of the moving averages also gives information about how strong price action has moved. Of course a Forex trader can always uses other methods such as calculating candle size, using ADX, or Bollinger Bands as well. But the moving average does a pretty good job of indicating whether recent price has been accelerating away from the moving averages or not.

Our Forex trading room uses the intermediate moving averages for this purpose, but a Forex trader could even add a short-term moving average (anything below 20) for this purpose.

Obviously the steeper the angle of the moving averages means that price in recent candles has been accelerating in its speed. Whereas the shallower the angle of moving averages means that price in recent candles has been relatively the same as previous candles. A good measurement is to use a clock. When the moving averages is pointed at 1pm or 5pm then this is a very strong uptrend for downtrend. When pointed at 2pm or 4pm, the trend is at a decent speed. If the moving average is travelling at anything between 2 and 4pm, then there is no trend or momentum.

CROSSOVERS

Beginning traders often try out moving average crossover strategy systems at first, but then they quickly realize that trading needs a more allround approach than one crossover. In our trading room we do not look at moving average crossovers. However, in some cases there is valuable information to be found.

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a)      Moving averages crossing moving averages could indicate a longer-term trend change, but would not suffice as a standalone strategy because the market creates too many whipsaws which eat the profitability. Also the crossover is a late signal and often the market retraces after such an event. The only benefit a moving cross over may give is to use it as a general guideline of potential long-term trend change.

b)      Price crossing moving averages has the same disadvantages as mentioned above. However if a fractal indicator is added than potential breakout trades could be identified due to price breaking the moving average and fractal support or resistance. Obviously a trending environment is a pre-requisite.

Do you use moving averages? If not, why not? If yes, why and for what purpose? Do you use multiple ones as well and if so, which type?

Hope you enjoyed this Forex educational article, thank you for reading and sharing this with our Forex traders! If you want to see these concepts used in a live market environment, then please take a look at our trading room!

In the meantime I wish you Good Trading and a great weekend.

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  • Nishebita Das

    Hi Chris, I read this article. Very well explained. Thank you.