How to Trade Using Moving Averages

Simplicity, transparency, and ease of use are just a few reasons why moving averages are among the most popular and widely used technical indicators on the market today. They come standard in every available charting package and trading platform. Many traders including the world's best and most experienced—rely exclusively on a combination of pure price action trading and moving averages to plan and execute trades. So a solid working knowledge of them and how best to use them within your particular trading strategy is an absolute must. 

What Do Moving Averages Signify, Anyway?

By definition, moving averages, or MAs, represent a running average of data from a given set of values. For example price over the last 10, 20, 50, or 200 days. Moving averages are used by traders, statisticians, and others, to smooth out regular fluctuations and better analyse prevailing trends. They are deemed "moving" averages because as more recent values are taken into consideration, an equal number of older values are removed from the calculation set.

Commonly used by traders to identify and confirm uptrends or downtrends. They can also help spot changes in momentum and even signal potential trading opportunities.

The two main types of MAs...

• Simple Moving Averages (SMAs): Calculated just by taking the arithmetic mean of the last "x" number of values. For example, the last 10 closing prices for a given asset or currency pair, in the case of a 10-day SMA.

• Exponential Moving Averages (EMAs): Exponential, or "weighted" averages use a rather complex calculation to give a higher degree of importance to more recent data. For example the 5 most recent prices when calculating a 10-day EMA. Fortunately, most any charting package and broker platform will measure and chart EMAs for you. It is not really necessary to study the formula, which you can see here.

There is plenty of debate across the trading community about whether EMAs are better indicators than SMAs. Like many things in trading, this is a decision best left to each individual trader.

Another key decision is how many periods to track using MAs. Whether to use minutes, hours, days, or other measures as your go-to period. Also there is some specific guidance to consider in doing this. Long-term traders will want to look at longer-term moving averages, obviously bypassing hourly measures. They will favour the 20-, 50-, and 200-day MAs. Conversely, intraday traders will examine shorter time frames, and likely use minutes or hours as the basis for their moving averages.

Our advice would probably be to start with 20-, 50-, and 200 periods, and feel free to experiment with others. Use demo trading to see if other parameters are more preferable for you and your style of trading.

How they can help you

Moving averages are considered lagging indicators as opposed to leading ones. While they are not intended for predicting future movements, they are useful nonetheless for providing traders a clearer picture of the trading landscape. Perhaps imparting some helpful confirmation as they plan and execute trades. Let us be clear about one thing in particular before we examine how best to use moving averages in your trading. It is important to realise that MAs are merely technical indicators that alone do not provide actionable trade signals.

When incorporated as part of your analysis process and trading strategy, however, you will likely find that moving averages are helpful measures. They can be used quickly and effectively without "clouding" your analysis. It also helps they do not impart too much extraneous information.

3 Ways to Use Moving Averages in Your Trading

Here is how we might recommend longer-term traders use moving averages to support their trading.

• To analyse trends & trend reversals: An upward-sloping moving average line is used, in part, to confirm an uptrend in the asset or currency pair being tracked. A downtrend is confirmed by a downward-sloping moving average line. Moving averages cannot be used to identify actual reversal points in advance as they are lagging indicators.

• To gauge momentum: Strong and decisive momentum is said to be present whenever the order, angle, and separation of a series of moving averages is noticeable on a chart. An example is the 20-, 50-, and 200-day MAs. In other words, to help confirm an uptrend has momentum working in its favour. For this to work the 20-day MA line would be above the 50. This in itself would be above the 200 (see below example in USDSEK). The reverse would be true in the case of a downtrend with sustained momentum.

• As potential chart support or resistance: Moving average lines on the charts are also considered strong support and resistance. With that, we are inclined to trade our go-to chart pattern, the pin bar reversal. This we will do whenever such a pattern prints with price approaching a moving average line.