Moving Averages Trading Strategies in Forex

Forex traders can create a simple trading strategy to take advantage of trading opportunities using just a few moving averages (MAs) or related indicators. MAs are primarily used as trend indicators and also identify support and resistance levels. The two most common MAs are the simple moving average (SMA), which is the average price over a given period of time, and the exponential moving average (EMA), which gives more significance to recent prices. These two elements form the basic structure of the Forex trading strategy below.

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Moving Average Trading Strategy

This moving average trading strategy uses EMAs because they are designed to react quickly to price changes. Here are the steps of the strategy.

• Draw three exponential moving averages (5-period EMA, 20-period EMA, and 50-period EMA) on a 15-minute chart.
• Buy when the 5-period EMA crosses above the 20-period EMA and the price, 5-period EMA, and 20-period EMA are all above the 50-period EMA.
• For a sell trade, sell when the 5-period EMA crosses below the 20-period EMA and the EMA and price are below the 50-period EMA.
• Place your initial stop loss below the 20-period EMA (for long trades) or otherwise about 10 pips away from your entry price.
• An optional step is to move your stop loss to breakeven when the trade is 10 pips in profit.
• Consider setting a profit target of 20 pips or exiting when the 5 period falls below the 20 period if you are long or when the 5 period crosses above 20 if you are short.

Forex traders often use the crossover between the short-term MA and the long-term MA as the basis for their trading strategy. Experiment with different MA lengths or different time frames to see what works best for you.

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Moving Average Trading Strategy: Types

Moving Average Envelopes Trading Strategy

Moving average envelopes are percentage-based envelopes set above and below a moving average. Therefore, the envelopes are not dependent on the type of moving average that is used as a basis, so forex traders can use whichever MA is most suitable, exponential or weighted. To determine the most effective envelope strategy for forex trading, traders should experiment with different percentages, time intervals and currency pairs.

It is most common to see envelopes over 10- to 100-day periods and using “bands” that have a distance from the moving average of between 1-10% for daily charts. If day trading, the envelopes will often be much less than 1%. On the 1 minute chart below, the moving average length is 20 and the envelope is 0.05%. The settings, especially the percentages, may need to be changed daily depending on volatility. Use the settings below to adjust the strategy to suit the intraday price action.

Ideally, you would only trade when there is a strong overall directional trend in the price. Most traders then only trade in that direction. If the price is in an uptrend, consider buying once the price approaches the middle-band (MA) and then starts to rally off of it. In a strong downtrend, shorting is appropriate when the price approaches the middle-band and then begins to lower away from it.

When you have a short, hit one pip stop over the swing high that just happened. When making a long trade, make reversing the stop-loss one pip below the swing low that formed recently. This is important. Take caution when trading at the lower price range on a short or long trade. Warning: Prices may increase during longer exposure periods. You can also set a target that is at least double your risk. For example, if you risk 5 pips, set a target of 10 pips from your entry point.

Moving Average Ribbon Trading Strategy

Using the moving average ribbon, one may develop a simple forex trading strategy centered on a gradual shift in trend. It can be applied to either an upswing or downswing in the trend.

The idea that more is better when it comes to moving average charting on a chart is the basis for the invention of the moving average ribbon. Eight to fifteen exponential moving averages (EMAs), ranging in length from very short-term to long-term averages, are plotted on the same chart to form the ribbon. The overall goal of the ribbon of averages that results is to show the trend’s strength and direction. A strong trend is indicated by a steeper angle of the moving averages and a wider gap between them, which causes the ribbon to fan out or widen.

The same crossover indications that are utilized with other moving average methods are also employed as traditional buy or sell signals for the moving average ribbon. There are a lot of crosses, therefore a trader has to decide how many of them provide a strong trading signal.

There is another way to offer trade entry that are minimal risk and have a large profit potential. The following approach seeks to capitalize on a significant market breakout in either direction, which typically happens after a market has moved for a considerable amount of time within a limited and tight range.

To use this strategy, consider the following steps:

• When the price flattens out into a sideways range, look for a period of time when all (or most of) the moving averages converge closely together. The different moving averages should ideally be so near to one another that they nearly create a single thick line, with minimal space between the distinct moving average lines.
• Place a purchase order above the range’s high and a sell order below its low to buffer the small trading range. Put a first stop-loss order below the trading range’s low if the buy order is triggered, and a stop order just above the range’s high if the sell order is.

Moving Average Convergence Divergence Trading Strategy

• Switch the signal line crossovers and the MACD. When the price is trending higher (MACD should be above the zero line), using the trend as the context, purchase when the MACD crosses over the lower signal line. When the MACD crosses below the signal line, it indicates a downtrend (the MACD should be below the zero line). Short sell.
• When the MACD drops back below the signal line, if the trade is long, exit.
• If you’re short, get out when the MACD crosses the signal line again.
• If you are going long, establish a stop-loss at the beginning of the trade, slightly below the most recent swing low. Set your stop-loss just above the most recent swing high if you’re going short.

Guppy Multiple Moving Average

Two distinct sets of exponential moving averages (EMAs) make up the Guppy Multiple Moving Average (GMMA). The first set contains the three, five, eight, ten, twelve, and fifteen trading day EMAs. This first set, according to Australian trader and GMMA inventor Daryl Guppy, “highlights the sentiment and direction of short-term traders.” The EMAs for the previous 30, 35, 40, 45, 50, and 60 days comprise the second set. The long-term EMAs are the ones that are modified if adjustments are required to account for the peculiarities of a given currency pair. The intention with this second set is to display longer-term investment activity.

It may be an indication that the longer-term trend is wearing thin if a short-term trend does not seem to be receiving any support from the longer-term averages. For an illustration, review the ribbon method from above. You could use the Guppy technique to make all of the longer-term moving averages one color and all of the short-term moving averages another. Look for crossings between the two sets, such as with the Ribbon. The trend may be changing when the shorter averages begin to cross above or below the longer-term moving averages.

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Advantages and Disadvantages of Using Moving Averages

In technical analysis, moving averages are frequently used to spot trends and possible trading opportunities. They are easy to use and suitable for any market and period of time. But traders need to be aware that there are benefits and drawbacks to employing moving averages.

Advantages:

1. Trend identification: By eliminating market noise, moving averages assist traders in determining the trend’s direction. They make it simpler to discern the overall trend and smooth out the price action.

2. Levels of support and resistance: Dynamic levels of support and resistance are provided by moving averages. They can be used by traders to determine possible entry and exit positions.

3. Simple to use: It’s simple to compute and apply moving averages. Traders can utilize moving average indicators that are integrated into the majority of charting platforms.

4. Analysis of numerous time frames: To gain a deeper comprehension of the general trend, moving averages can be applied to multiple time frames.

5. Versatility: The accuracy of trading signals can be raised by combining moving averages with different technical indicators.

Disadvantages:

1. Lagging indicator: Because moving averages are dependent on historical price behavior, they are lagging indicators. In markets with rapid fluctuations, their indications might not be precise.

2. False signals: In erratic or sideways markets, moving averages may give misleading indications. Traders should be aware of this and confirm trade signals with additional indicators.

3. Whipsaw trades: When the price crosses the moving average more than once in a little amount of time, it might result in whipsaw transactions. Traders may suffer losses as a result of this.

4. Not appropriate for every market: Moving averages might not be appropriate in every market. They may not be useful in range-bound markets and perform best in trending markets.

5. Over-reliance: Traders may rely too much on moving averages and overlook other crucial technical indicators or the principles of fundamental research.

Although moving averages are a helpful tool for traders, they are not without drawbacks. To make wise trading decisions, traders must be aware of the limitations of moving averages and utilize them in conjunction with other technical indicators and fundamental analysis.

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