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How to Use Moving Averages in Forex Trading |
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07th Oct 2020

How to Use Moving Averages in Forex Trading

The forex market has been marked by high volatility during 2020, with the Covid-19 pandemic, trade wars, change in inflation rates and the US election, all coming together in a single year. These are the conditions where a moving average strategy can be a great tool for traders.

Moving averages is a popular technical indicator, used to smoothen out price movements. It achieves this by creating a price point that is constantly updated. This makes it easier to spot trends, allowing traders to see beyond the impact of short-term fluctuations within a specified timeframe. 

There are several types of moving average strategies. Here’s a look at the most popular ones for forex trading.
Exponential moving averages is a highly popular strategy for forex trading. It is also known as exponentially weighted moving averages because higher significance and weight is placed on the more recent data points. This results in the EMA reacting more strongly to price changes that are the most recent.
Here’s how you can use the EMA strategy:
  • On a 15-minute chart, plot a 5-period, 20-period and 50-period EMA.
  • When the price of the 5 and 20 period EMAs is greater than the 50-period EMA and the 5-period EMA cuts the 20-period EMA, while rising, it is considered a buy signal.
  • It is considered a favourable time for selling when the 5 and 20 period EMAs are below the 50-period EMA. Plus, the 5-period EMA crosses the 20-period EMA, while declining.
  • The stop-loss order can be placed below the 20-period EMA.
The moving averages convergence divergence line is calculated from the difference between a 12-period EMA and a 26-period EMA. On top of the MACD line, a 9-day EMA, known as the signal line, is also plotted. This line often acts as a trigger for selling and buying signals. 
Here’s how you may trade using MACD trading:
  • In case the market is on an uptrend, buying when the MACD line cuts the signal line while rising may be a good option. The MACD line should not be below the zero line for this. During a downtrend, when the MACD line cuts the trend line while falling, short selling may be a good option. The MACD line should not be above zero.
  • If you are going long, the stop loss may be placed beneath the last swing low. If going short, the stop loss may be placed over the last swing high.
In this strategy, a set of 8 to 15 moving averages of different lengths are plotted on a single chart. This creates a ribbon pattern.
Here’s how you may trade using ribbon patterns:
  • When the price moves above the ribbon or over most of the moving averages, it signals an uptrend. This may be a good time to buy. Upward angled MAs also help in confirming an uptrend. 
  • When the MAs are downward angled and the price drops below most of them, it signals a downtrend. 
  • If the ribbon is widening, it signifies that the trend is becoming stronger. Conversely, a narrowing ribbon signifies a weakening trend. 
  • Moving averages can be immensely helpful. But to get the most out of them, it is best to use them along with other indicators, such as price action, to confirm the signal.