Using Moving Averages
The most important use of moving averages is it determines the market trend.
To make it easier, traders plot a single moving average into a chart. When price action maintains above the moving average that means the price is generally in an uptrend. If the price action stays below the moving average then it would only mean that the price action is in a downtrend.
As we have discussed in our previous articles, when it becomes too simplistic, it can give you a ‘fake’ analysis if you are not too careful.
Let’s say for example, USD/JPY has been going in a downtrend. But all of a sudden, a news report came out, causing a sudden surge.
If you are to plot this on a chart, the sudden surge in price makes it look like it is above the moving average. If you are not too careful, you may think that this is the best time to buy! So impulsively, you just do exactly that.
But continuously looking at it shows that USD/JPY is still going a downtrend. The sudden lift on price action was just dictated by traders reaction to the news. So if you just did exactly what you thought, you could have been faked out!
What most traders do, is they plot two moving averages on their charts as oppose to just one. How will this help you?
So we said you create two moving averages: one the “faster” moving average, and the other one – “slower” moving average. In an example, a 10-period moving average (faster) and a 20-period moving average (slower) on one chart.
When there is an uptrend, the “faster” moving average is always above the “slower” moving average.
So when you see on your chart that the 10-period moving average is above the 20-period moving average, this signals an uptrend. This can further help you to decide if you would go long or short currency.
Do not limit yourself with just two moving averages. You can always go more than two, from fastest to slowest moving average to give you a better view of an uptrend or a downtrend.
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