Using Moving Averages in Forex

One of the most basic indicators in Forex is the moving average. You will probably learn about moving averages before you learn about any other technical indicators. What is a moving average? Think of it as a graphical display of price action over time, smoothed out through a mathematical equation. A moving average shows you the average closing price (you can set it to something else if you prefer) for the last N number of periods, where N is a number you select.

The main types of moving averages used in Forex are simple and exponential. The longer the period you select, the smoother the moving average will appear and the more slowly it will react to changes in price. The shorter time periods will result in a choppier looking moving average which reflects a more recent time. These moving averages react more quickly to changes. Exponential moving averages give more weight to the more recent periods, which helps to eliminate some of the static caused by one-time events and spikes in price. You can look up the formulas for calculating simple and exponential moving averages, but thankfully you do not need to do the calculations yourself. Charting software like MetaTrader can take of that for you. All you need to do is select the type of moving average you want and the period.

You also need to know what to do with the moving averages once you have displayed them on your chart. There is no "right" or "wrong" way to use moving averages; some Forex traders build entire systems around them while others just use them as guidelines — a way of conceptualizing what is going on in the market. Still, others use them as support and resistance. One good idea is to display a couple of moving averages on your chart and not just a single moving average. A faster and slower moving average help you to see the general trend over a longer time period as well as a picture of what is going on now. A common tactic is to wait for the faster moving average to cross above or below the slower moving average. Since the slower moving average is acting as support or resistance, a break of the line can signal a profitable currency rate movement.

You may also use moving averages simply to gauge where you may encounter support or resistance in the middle of a trade you are already in — or as context to decide whether to take a trade at all. If you have an otherwise nice-looking setup using your chosen indicators, but you have a confluence of two or three moving averages in your way, you may wish to move out your entry and wait for price to break the moving averages. You may also want to exit a trade early if you find that the price is hovering around a moving average; this is something what you will need to test for accuracy and profitability. Whatever moving average method you come up with for your trading, conduct thorough backtests and demo tests before going live with Forex.