Trading Forex With Moving Averages

Posted by admin | Posted in Forex News | Posted on 30-07-2010

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Moving Averages are popular and common trading indicators, used by countless traders worldwide. They are one of the oldest and more tested analysis tools in the markets, used for decades. In this article we will describe several trading methods and their strengths and weaknesses.

Moving Average is a very simple indicator – their are calculated by averaging all the previous closing prices. While there are several techniques of calculating averages, we will describe trading methods that are used regardless of exact calculation.
The main trading methods of Moving Averages are:

Method #1: Cross
This is the simplest and most well-known trading methods is the cross. In this method the trigger for entry is a cross of an MA by price, or by another MA which is quicker (has a lower period of calculation). For example, when a price crosses MA from below it will signal a long entry and a cross from above will signal short entry. This technique is generally a trend-following one and therefore also highly lagging: signals are given after price has began to trend and trader usually misses a major part of the trend. It is a useful system in trending FOREX pairs and commodities, and it losses in ranging markets with weak trends.
Many automated systems trade this method, whether directly or indirectly. Try to avoid such trading method as it performs only in narrow market conditions (strong trends) which are take places only in 20% of the time. If you choose to trade the cross, try to filter the signals using a trend filter like a Stop Order (that enters a trade after price advances a certain amount of pips). This increases the hit rate and profit potential of the cross method.

Method #2: Bounce
This is a more sophisticated trading method that is not as common as the cross, but is considerably more profitable. A bounce occurs when price touches a trending MA and instantly reverses, ‘bouncing’ off the Moving Average. In this method, the Moving Average performs as a support or resistance level that is blocking price.
This method produces much stronger signals which have several major advantages: First of all, because trades are issued on support and resistance, trader knows where to place its stop loss which is usually very tight. Second of all, the trader confirms that ‘the trend is on his side’, but enters with a leading signal rather than lagging.