Trading forex with indicators is a little like joining dots and making money when a few lines cross. Simple, straightforward and very transparent, Forex moving averages are the most widely used and arguably the best, forex indicators. These popular indicators are used in conjunction with forex candlesticks to gauge the direction of a current trend, be it up or down. If you have a good idea of which way the market is going, you have a good chance of profits.
Forex Moving Averages
Forex moving averages are the perfect way to start your forex trading career and winning pips. Currency trading strategy (note: not strategies) because it can be used as a stand-alone trading system. With so many methods around it is easy to get lost in the crowd, lose focus and get distracted, the reason so many fail at forex trading. Get the basics right and the rest will follow. Find what works, duplicate the success then refine, repeat and grow.
Why Use Forex Moving Averages?
Forex moving averages fall into the ‘technical analysis’ banner or forex charting. At school, I asked a teacher if the exam was hard. He said “No it’s easy…If you know the answers.” Once you have an idea of how a chart works it won’t take long to familiarize yourself with a chart and know exactly what’s going on. The forex moving averages are plotted over a very simple forex candlestick chart and help you identify trends, the direction the market is likely to move so you can pick the most profitable entry and exit points. Trading forex with indicators is about picking the most likely trades to profit. You earn your forex pips by knowing the best times to enter and exit, all determined by these very simple averages.
So, what are Moving Averages?
The two most popular (or arguably best forex indicators) are the ‘Simple Moving Average’ and ‘Exponential Moving Average’. Your forex charting software will work out the averages, understanding the key difference will help you in choosing the right indicator for your trading personality.
Simple Moving Averages (SMA):
Once you break the phrase down, you’ll be kicking yourself at how easy it is to understand. Forex traders generally work with a favorite time period, from 1 hour to several days. Say you are working on an hourly basis and you want to plot an 8 point chart. You collect the last 8 closing points (i.e. one for each hour you have traded), add them together and divide by 8. That gives you the average. Some would call this the mean. Now the ‘moving’ part. This means that the average is calculated on a rolling basis. It’s easier to explain with this example:
Yesterday: 1 2 3 4 5 6 7 8
Today: 2 3 4 5 6 7 8 9
Tomorrow: 3 4 5 6 7 8 9 10
Yesterday’s SMA was an average of the price points 1 – 8. Today we have a new price point 9. We are working on an 8 point period so we calculate today’s average using the prices 2 – 9 and lose 1. Tomorrow we have another point (10) so we have to lose point 2 is we are using an 8-period moving average. A typical forex price chart can look very erratic and forex candlesticks can obscure the pattern further. The moving average gives a smoothed graph that is plotted on top of the forex chart, alongside the Japanese candlesticks.
It is worth noting, you can use any time periods you like, for example, a 5 hour or 200 days. The greater the period used, the greater the smoothing. There are advantages and disadvantages to this. Most traders will use a combination of forex moving averages before opening or close a trade. Since we are using historical data, it is worth noting that moving averages are ‘lag indicators’ and follow the actual period the greater the responsiveness of the graph and the close it is to the actual price line.
Exponential Moving Averages (EMA):
An exponential moving average is a variation of the simple moving average. An SMA gives each price point the same weighting. If you are working on an 8 period SMA it would assume that the 1st price and the 8th price were equally important. Most Forex Traders give extra weight to recent prices, they are more concerned with the now. Using the same example above, the 8th price point would be more important than the 1st. By given it ‘more weight’ the Exponential Forex Moving Average line is more responsive to price changes. This means you can identify trading opportunities quicker and act faster. The downside is that you are subject to false alarms if you act too quickly.
Traders generally favor using the exponential moving averages to get their forex (fx) pips. Focused on getting pips, currency trading strategy will generally give greater importance (or weight) to recent prices. It is worth using both alongside each other to start with to find what works best for you (or perhaps a combination of both using different periods). Like the SMA, these are also lag indicators. Trading with forex indicators can be quickly and easily picked up and put into action. With as little as 10 minutes per day, you can check a price chart, plot your forex moving averages and decide if today is a profitable day to trade.
Remember it’s not about how often you trade; it’s about how profitable you trade.
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