We’re Moving Averages Part II

Today we finish our two part series on moving averages with “Moving Averages Part II.”Yeah I know some of you don’t want this series to end, but all good things must come to an end. Just to refresh your memory we started off with We’re Moving Averages Part I. We defined moving averages and took a look at the two main averages tools – Simple Moving Averages a(SMA) and Exponential Moving Averages(SMA).

Today we’re going to close the show by learning how to use moving averages to find trends.We’ll then find out how to use  moving average crossovers to enter trades, and lastly, how to use moving averages as dynamic support and resistance levels.

So let’s start off with:

Use Moving Averages To Find Trends

It’s possible to use moving averages to find trends. If anything,moving averages help you determine the trend. You can start by plotting a single moving average on the chart. But remember this: When price stays above the moving average it means that price is in an uptrend.And when such a scenario unfolds,,it’s your signal to enter a trade. Let’s take a look at an illustration of this scenario.

moving-trend

As you can see, the blue line represents the moving average. And if  the price is higher than the moving average. It’s time to put in a buy trade and laugh all the way  the back.

get hairy sometimes. Let’s say USD/JPY goes into a downtrend.But a news report causes the price to surge even higher. You  then discover that the price is now above the moving average. So you say to yourself.  “Hmmm…How about I put in a buy trade now  that the market is hot”? So you put in a buy trade  with the confidence of a soothsayer that USD/JPY  will surge further  upwards. Suddenly, out of no where you get faked out.(Remember the fakey pattern?) Instead, the trend goes downward, and the price keeps getting lower, leaving you holding the bag.. Let me show two illustrations of this scenario.

Change-Trend

The USD starts a downward trend. Then all of a sudden,an uptrend starts taking shape.Of course you gets sucked into believing it’s time to make a buy trade.

 

fakeout

As you can see , you get fooled by the market as it continues with its downward slope,leaving you  holding the bag.

The moral of the story is that you plot not one, but two moving averages. Why? because with two averages you get a clearer signal of whether the pair is trending up or down, depending on the order of the averages. One thing you need to understand is that in an uptrend the faster moving average should be above the slower moving average.It’s vice-versa for the downtrend. Let’s take a look at a 10 period MA and 20 period MA.

10-20

As you can see an uptrend is developing  nicely here with the 10 SMA above 20 SMA. With two trend lines,you should be able to tell whether a currency pair is trending up or down.  Assuming you’ve finally figured out how use moving averages,you can  combine that with your knowledge of trading trends  to decide whether to go long or short on a currency.

If you want to get adventurous, you can put more than two lines on your chart. Just make sure the lines are in order of importance(Fastest to slowest in an uptrend, and slowest to  fastest in  a downtrend.This way you can tell whether the currency is in an uptrend or downtrend.

By the way if you’re still at sea about trading trends, go back to my post Trade Trends With Price Action Analysis

Use Moving Average Crossovers to Enter Trades 

It’s also possible to use moving average crossovers to enter trades. No, I’m not referring to Kobe Bryant’s deadly crossovers.  I’m referring to moving averages crossing over each other. How do you  discern these signals?Just plot a couple of moving averages on your chart, and hang tight for a cross over. If one moving average crosses the either,it’s a signal that a trend is about to change. This trend switch is your queue to make a solid entry. and a chance to cash in big.

Let’s take another look at  the USD/JPY daily chart to explain moving average crossover trading.

.crossover

Between April-July, the pair seems to be in a good place trend-wise. Then it reaches its peak at 124 before  before making the downward spiral. By mid-July, the 10 MA crosses below the 20 MA. And what happens next? A nice downtrend takes shape. This downtrend takes shape because of the two moving averages crossing each other.

One thing you need to understand is that yes, a crossover system works wonders in a trending environment. But it flames out in a consolidation environment;when prices  start ranging. And when that happens it make take a while before you spot another trend.

Using Moving Averages As Dynamic Support and Resistance Levels

It’s even more possible to use moving averages as dynamic support and resistance levels. If you’re wondering whether you’ve come across this term before, yes you have.You saw it in my  Something Called Confluence post. Dynamic support/resistance levels are not like their static horizontals upport/resistance brethren. Dynamic support/resistance levels are constantly changing faces depending on current price action.

A lot of forex traders view moving averages as key support or resistance. These traders buy when price dips and tests. the moving average. Or they buy when price rises and touches the moving average. Let’s take a look at the 15 minute chart of GBP/USD for illustration

 

It seems 50 EMA is holding the line quite well.Whenever the price approached 50 EMA,and tested its mettle, it hit right back and forced price to bounce back down.

But there are times price will elude EMA  before reversing in the direction of the trend. And there are also occasions when price will just bamboozle through EMA all together. What you could do in such a scenario is plot two moving averages on the charts You buy or sell only when price is in the space in between the moving averages. This area is also as the zone.

Let’s take another look at this same 15 minute chart using 10 and 20 EMA’s

price-zone

Fromt he look of things, price drifted past price few times, but start heading downwards afterwards. The whole point of this strategy is that just like hrizontalsupport/resistance levels, the dynamic version should be viewed as zones of interest.Think of the area between the moving averages as zones of support or resistance.

Break Through Dynamic Support and Resistance.

Just like any barrier, you have to break through dynamic support and resistance. As you already know,moving averages at as support and resistance. But they can be brittle at times-causing them to break just like any other support/resistance level.

The 50 EMA on the GB/USD’s 15 minute chart should clarify things

dyna-zone

It looks like it held really well! Every time price approached 50 EMA and tested it, it acted as resistance and price bounced back down.

There are also times when price just bamboozles past EMA  altogether. What you do in such a scenario?   Plot two  moving averages, and only buy or sell once price is in the middle of the space between the two moving averages. You could call this area “the zone.”

If you’ve stumbled in here looking to join the forex trade bandwagon, here is what you need to do . First,  look up Why Forex Trade Is So Popular.  Next, you learn  the fundamentals of forex trading by reading  Forex Trading Basics – Top To Bottom Part I  and Forex Trading Basics – Top to Bottom Part II .Next, you need to learn how to read candlestick patterns. They are the main feature of price action analysis And you need to know what these patterns are telling you. To be able to do that read the following on Fundamentals of Reading Candlestick Patterns, Single Candlestick Patterns,  Dual Candlestick Patterns, and Triple Candlestick Patterns .    Also You Need To Know Ten Of These Candlestick Patterns . And finally If you want to give your trading skills an edge by relying on pure price action trading/analysis,  instead of fancy forex robots and fancy indicators, get started with What is Price Action Trading? 

Looking to get a leg up on price action analysis,?you need to learn How to Identify Support and Resistance Levels.  And if you want to learn how to interpret trading zones, read up on Identifying Dynamic Support and Resistance Levels. Finally you should know  How To Read Candlestick Patterns using Support and Resistance Levels.

However, if you only want to trade once a month and watch your entry rack up huge profits over a stretch  of several weeks, consult  How to Spot High Probability Trades.  And if you  are  still not sure about  price action trading, find out   Why Price Action Trading Still Rocks . Dont let me stop you from reading the other posts as well. But the  suggested posts above are the most important posts to get  you started.

Well,that’s a wrap for”We’re Moving Averages Part II.” We learnt that moving averages can be very useful tools in price action analysis. They help forecast prices in both present and future.The trick is trying to choose which moving average to use for your analysis.I hope you’ve had fun as much as I have. I know I have.

Do you want me to send you the latest posts to your email address inbox?Then  subscribe to my mailing list and I’ll send my blog posts direct to your inbox. It wont cost you a penny. Till next time,take care.

P.S. If you want to know everything there is to know about price action trading  Download for free The Ultimate Guide To Price Action Trading by Rayner Teo .This brilliant ebook will change your life as a trader. It sure did mine. And if you want a place  to put your price action trading strategies into practice(Including Moving Averages Part II), and get a simulated feel of live forex trading conditions   before trading live, open a free demo trading account with Easymarkets. And if you believe you are ready to trade live on the forex markets, open a forex trading account with EasyMarkets and get a free forex trading ebook

 

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10 thoughts on “We’re Moving Averages Part II

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