Moving averages are one of the most popular indicators to be used in technical analysis and the reason for that comes from the simple fact that they are visible and offer a clear bullish or bias view to any trader.
They are trend indicators and this means they are being plotted directly on the chart, when compared with oscillators that are plotted below the actual price candles. Having said that, it means traders are using moving averages to find out places to enter in a trend, namely to buy dips in a bullish trend or sell spikes in a bearish one.
There are multiple types of moving averages but the most popular ones are the SMA (Simple Moving Averages) and EMA (Exponential Moving Averages). I will always recommend an exponential moving average as it is reflecting and adapting to price movements more accurately than the simple one.
Like any indicator, different periods can be used in order to plot it, and it goes without saying that the bigger the period, the bigger the support and resistance are. The most popular bigger period to be used for a moving average is 200, and this means that two hundred candles back in time are used to plot the line.
The bigger the time frame, the bigger the support and resistance level offered by the moving average and it is being considered as a rule of thumb that as long as price stays below the MA (200) the trend is bearish, while if it stays above it a bullish trend is in place.
The chart above shows the recent AUDUSD four hour time frame and the EMA (200) (exponential moving average). As explained earlier, as long as price is staying above the average, it is considered a bullish trend, while below it is a bearish trend.
But how to do you enter a trade? A very good strategy is to use different moving averages on the same chart and to stay with the trend as long as the lines are not crossing. As for entering a trade; look for support or resistance when the time price is reaching the different moving averages.
The other moving averages to be used are the MA (100), MA (50) and sometimes even MA (20). I wouldn’t recommend more than four averages on the screen as the chart will become too crowded and the price action will be difficult to understand.
Above there are the four moving averages explained earlier with the blue one being the MA (100), the brown one MA (50) and the pink one MA (20). They are offering a pretty solid picture about the strength of a trend in the sense that the first bearish sign in a bullish trend is given by the inability of the MA (20) stay above the MA (50), with the opposite being valid in a bearish trend.
Therefore, it is only normal to buy dips into moving averages before price is reaching the two hundred one, in a bullish trend. On the left side of the above chart, more aggressive buying should take place as price is reaching the blue line, and by the time it is jumping above the pink one, stop loss should be moved at break even or even trailing the stop would be a smart thing to do.
On the right side of the chart on the other hand, price is not able to reach the blue line, the MA (100), so selling should be on the cautious side, on the pink and brown averages, with stop loss at break even and trailing stops.
Therefore, the short term implications in a trend are being filtered through the lower moving averages, while the medium to long term implications are being filtered through the higher moving averages. It is being said that when the MA (100) crosses with the MA (200) the general trend has changed.
This is just an example on how to trade with moving averages but there are multiple other ways to interpret them and they are a must have tool in any trader’s toolbox. It goes without saying that being trend indicators they need to be accompanied by something else, like an oscillator or Elliott Wave Theory, but in principle strong support and resistance areas can be easily identified.
One precious tip maybe that the more moving averages are converging into one single spot, the more difficult for price to break that area. In this case, it is being called that a cluster of moving averages held price for moving forward.
Our next article here on ForexGator.com will be dedicated to Japanese candlestick techniques, and the theme will be bullish and bearish engulfing.