Moving averages (regardless of the period used) all have the same aim:
They identify trends over specific periods and they smooth out the day-to-day price fluctuations that are a consequence of short term volatility to help you see the longer term trend.
The equation is:
The closing price is added up and divided by the period the moving average is calculated over.
Popular Periods
200 Day moving averages are popular ( particularly in the stock market) for tracking longer term trends and 20, 40 and 60 Day moving averages are used to spot and identify the intermediate trends on forex charts. Shorter Periods are used and many forex traders will calculate moving averages within a day.
Moving averages are one of the simplest and most popular used by traders interested in technical analysis and are a great trend identification tool.
The problem most traders have is using them correctly and they normally make to fatal errors.
1. They are NOT a leading Indicator
Many forex traders use moving averages to execute forex trading signals without any other confirming indicator and this is a huge mistake. They fail to understand that:
Moving averages are a lagging NOT a leading indicator.
They are like a trend line and simply give the direction of the trend in the time period that they are calculated over.
Many currency traders like to buy dips to a moving average to initiate a trade that the level holds but this simply leads to loses. If you hope in any investment market you will lose your equity quickly. Moving averages should not be used as a leading indicator and you should time entry with a momentum indicator such as the stochastic or Releative strength Index to Confirm the level should hold and get the odds on your Side
Moving averages are great for showing you layers of support and the trend but cannot be used to enter forex signals they need to be combined with other indicators - If you do not do this you will lose.
2. Short time periods indicate nothing
The shortest moving average we would use would be 18 days, however we have seen traders using moving averages within a day and plotting them hourly!
Volatility in short time frames is random and there is no trend - day traders who use moving averages lose, not becuase moving averages area bad indicator but simply it is impossibkle to calcualte a trend in short time periods.
Moving averages are a great tool for indicating support or resistance in the market and can add a valuable extra tool to your trading armoury, if you use them correctly:
To identify the trend, support and resistance levels and then combine them with a momentum indicator to enter your trade and finally use periods of a least a week and nothing shorter! It's an easy and profitable tool if used in the right way.
