The simple moving average is one of the most effective tools you can use. It’s simple to understand and easy to use and if you are interested in getting in on trends, its one of the best forex trading indicators if used correctly…
Here we will look at the best periods to use and how to apply them but first let’s take a look at the the equation for a moving average is very simple and is:
The closing price is added up and divided by the period of the moving average.
You can of course use as many days as you like, traders typically use between 5 and 200 days but which ever time frame is used, the aim is the same:
To identify trends over specific periods of time and smooth out the day-to-day price fluctuations caused by market volatility.
This is based on the concept that short term price spikes, are simply caused by human emotion and don’t last and prices will return back to the moving average or fair value. The real value of moving averages is in finding value areas to buy or sell back into in strong trends and when, a moving average is broken, to indicate when a trend is over.
What are the best Time periods?
This of course is all down to personal preference and to a degree how volatile the market is you are trading.
My own view based around 20 odd years of trading, is that short term averages are of little use i.e. under 10 days. Why? Because you are trying to get the longer term value and if the average used is to short, it ends up being part of the price spike!
Two Periods I Like are:
20 Day MA
When a market is trending strongly and you want to get in a trend – look at a 20 day Moving average to buy or sell back to. This is an excellent one to use, simply wait for the move to the value area and time your trading signal. If a market is trending strongly, this will give you plenty of opportunities to get in at good risk to reward.
40 Day MA
I like this one as my last line of defense in a trend to trigger a stop loss and go flat and also to indicate if a new counter trend may be emerging.
The two above are time periods I like to use – but everyone has there favorite period to put into their forex trading strategy.
Simple Yes but Very Effective if Combined with Momentum
Moving averages maybe simple but the logic is timeless. Price spikes are emotional and don’t last and prices will always come back to fair value again and a look at any forex chart will show you this. This repeats over and over again, as human nature never changes and moving averages allow you to spot areas of value.
While we consider it one of the best forex trading indicators for trend followers and use it – never simply buy or sell, without confirming price momentum is in your favor first. It identifies the area to watch NOT the trading signal.
In the next article in this series we will look at the best momentum indicator to use with moving averages for better market timing.