Moving Average is a basic mathematical tool that can be used even as stand-alone indicator to trade in the markets but if you mix it up with some other indicators, it can be quite a useful tool. As the name suggests it is the Average of the shift in the market over a certain time period. The main types of Moving Averages that are used by different traders are;
1. Simple Moving Average
2. Weighted Moving Average
3. Exponential Moving Average
I will not go into the definition or details of each type as information on them is readily available.
How to use Moving Average?
I basically only use Simple Moving Average indicator for trading. These types of indicator are more effective in slow moving currencies and commodities but are quite useful in volatile forex markets as well. I prefer using it on daily charts as their movement allows some good margin to apply my risk and money management techniques in a most effective manner.
I use basically the following values for Moving Averages:
The reason for using these values is that in theory there are 5 working days in a week and around 22 in a month. Considering that some companies work on 3 months planning so Moving average of 55 is indicator of long term trend. Similarly Moving Average with 100 is useful because it is a major figure, although it is often very slow in indicating the change but still no harm using it along with others. So our basic focus is Moving Average of 5, 22 and 55 time periods.
Now focusing on 55 Moving Average, it basically indicated the trend, so if it is going and pointing upwards then it is indicating Bullish market and similarly if it is pointing downwards, it is indicating Bearish Market.
Now if 22 Moving Average is above 55 Moving Average and Long Term Trend is Bullish, then it is a clear indication of buying at reasonable level and best suited point is when the market will touch the 22 Moving Average. Often it is seen that in case of Bullish market when market crosses below 22 Moving Average, it next dips towards 55 Moving Average and thus aggressive traders choose to trade market in reversal but that is not highly recommended as trading against the trend carries more risk and less profit ratio.
The 5 Moving Average basically moves very close to the market and generally I use it to indicate entry levels which are well suited to short term as well as aggressive traders.
Precautions and Recommendations:
Moving Average is a bit slow in indicating overall trend so using it alone cannot be that useful as compared to using it in addition to other tools. The traders looking for safe entries should wait till the time they have clear indication of all Moving Average to enter the market.
Also always use a good backup plan and stops to limit your risk of losing on trades. And last but not the least, practice trade well before trading a real account.
In the above figure, Moving Averages are used as follows: RED (5), BLUE (22), GREEN (55) and WHITE (100). Here you can see it is a good indication of Bullish Market and aggressive traders will look to target Red Moving Average (5) and once it breaks below that, next target will be around Green (55). So if I am an aggressive trader, I will buy this item around 83.50 with a small stop and next will buy around 82.75 with reasonable stop.
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