Forex markets: A step-by-step guide in using moving averages in forex trading strategy
As we have seen earlier, one of the most commonly used technical indicators in making buy or sell decisions in forex trading is the use of moving averages. We have also seen that there was no significant difference between the use of simple moving averages and exponential moving averages. They both produce the same kind of signals and you may choose whatever suits your trading style best. There has never been any decisive evidence that simple averages are better than exponential averages or vice-versa. Remember to be consistent in the use of your technical tools.
Simple averages are an arithmetical mean of the closing prices of the days in question there is exponential averages weight the prices with the most recent being given the maximum weight. There are many sources from which you can pick up your information and the best forex broker would always provide you with the charts that you seek. Settle for what are you find the most reliable and convenient for your trading needs. Here are the steps that you should follow:
Step number one: get a feel for the long-term direction in which the market is headed. Use 200 day average for the purpose. If the market price is above the 200 day average, it is likely that the market is on an uptrend and it is an opportune moment to buy. If the market price is below the 200 day average, which is likely that the market is on a downtrend and it would be advisable to sell or go short.
Step number two: crossovers are the system most commonly employed to determine whether to buy to sell. You can use two moving averages for the purpose. For instance if you are using the four-day and the nine day averages, and the four-day average crosses the nine day average moving upwards, this is generally taken as a signal that you should buy. Similarly if the four-day average crosses the nine day average moving downwards, it is taken as a signal that you should sell. For a longer-term trend, you should use longer-term averages such as the 50 day or the 200 day average.
Step number three: some traders prefer to use three moving averages for their crossovers because they feel that this provides less volatility to the system. For instance, for your short-term trading, you may wish to use the four-day, the nine-day and the 18 day moving averages. For a buy signal to be generated, it is essential that both the shorter term averages must cross the longest average in an upward direction. In our case both the four-day and the nine day average must cross-over upwards over the 18 day average. Note however that for a sell signal to be generated, it is necessary only for one of the two shorter term averages to cross over moving downwards over the longest term average. In our case, it is sufficient if either the four-day or the nine-day average cross-over moving downwards over the 18 day average.