The Use of Moving Averages
Moving Averages may be the most popular technical indicator because they are easy to understand. After all, a 10-day Simple Moving Average is calculated by just taking the closing prices of the last 10 days, adding them together and dividing by 10.
We can then plot those daily numbers on the chart to smooth out the market movement and get a better feel for the mood of the market. Many new traders run into problems as they use the market price crossing the Moving Average or a crossover of two Moving Averages to enter and exit the market. Typically they find that their entry and exit are late and very often find themselves with a losing trade. However, the use of Moving Averages can be of great help in determining the direction of the trend or for showing possible support and resistance levels. Here is a daily chart of the EUR/USD with one year of data and a 100-day Simple Moving Average.
We can see two things with the chart. The first is that since the Moving Average is moving up and the price is above the moving average, we can conclude that this pair is in an uptrend. We can also see where the market has pulled back off of its highs a couple of times and found support at the Moving Average. So if we are buying pullbacks in uptrends or selling rallies in downtrends, the use of a Simple Moving Average can help us better time our entry. This simple technical indicator has a lot of value it today?s trading environment, but we just have to be sure we understand its strengths and weaknesses to better judge its effectiveness. Good luck with your trading!
Written by Thomas Long, FX Power Course Instructor