In this post, we are talking about simple moving averages in Forex. Like every indicator, a moving average does lag behind price action itself, and in my opinion, a simple moving average by itself is not going to provide you with great trading opportunities.
Still, simple moving averages can be used in a variety of ways to provide some clarification for you in the Forex Market. In this article, I am going to talk about a few ways that you can use simple moving averages to guide your trading. Again, I wouldn't really recommend that use a basic indicator to mold your entire strategy, but I do think it can be a helpful tool in your belt as a trader.
The first and most obvious, way that you can use a simple moving average (or SMA) is to determine the trend. An SMA is an obvious representation of how the price is moving over a given period of time. You can also read about Trader Profile Quiz.
Clarification with Simple Moving Averages
For instance, if you open a 4hr chart with a 20 SMA, you would see something like this:
Now, it doesn't take a Rocket Scientist to figure out that this is a downtrend without the SMA in place, but it does give you a frame of reference as to how the price is flowing. In other words, we already know the price is going down without the help of the Simple Moving Average, but having it on the chart might clarify the pace or the steps that it is moving down in.
That is pretty basic, and for the most part unnecessary, but an SMA can provide a LITTLE more information than that... For instance, you could put a larger moving average on the same chart to get an idea of what the longer time frame trend looks like even while you look at the 4 hr. Let's take a look at the same chart with a different SMA on it.
On this chart, we have the same 20SMA that I had before, but I also added a larger SMA to represent the weekly chart. Now when you look at the chart, even though it is still falling heavily, you can see that the weekly trend is relatively sideways.
Using a larger SMA like we did in this example can tell you a few things. One thing it might tell you is that a trend like this on the 4HR is ready for a bounce to the upside to re-align itself with the longer time frames. If the SMA representing the weekly chart was also headed steeply downward, it could show you confluence, and support the idea of taking a long-term shorty entry.
Using multiple SMA's is a great way to make multiple time-frame analysis much simpler.
Another way to use an SMA is a filter of a given strategy. If you have a strategy that has potential but needs some filters, you may want to see if an SMA can play a role as one of those filters.
For instance, you might have a price action set-up that you like, but you find that it is getting you into too many bad trades. You could potentially add an SMA to your plan and require the price to cross through a given SMA or pull back into an SMA in order to qualify an entry. Also read about the hidden secrets of moving average.
Implementing a Simple Moving Average into a strategy:
So, in this example, a trader might be taking bullish, momentum bars after pullbacks, but to add a filter to their Trading System, you could also say that it needs to cross through the 30SMA on the time-frame that you are looking for the entry on. This is just example of a simple moving average trading strategy.
Similarly, you can use SMA's to define "The River." The river is a term used in trending markets to show when the price is pulling back and ready to launch to a higher high or a lower low. In the example I am showing you below, the river is defined by the 20 and 40 SMAs. The 20 in black and the 40 in green. Notice how often price tends to pull back into the river before making a new high (in this case it is a high because of an up-trend, but it is also true in a downtrend when it is making new lows).
Price Action and SMA
You can see that many of the pull-backs come in between the 20 and the 40 before reverting back into the trend. There are between the 20 and the 40 Simple Moving Average is referred to as "The River" and can be used to help identify areas to get back into the market during trending periods.
Along with the idea of SMAs being an area f the r price to pull back into before moving in the other direction, an SMA can also be a point of support and resistance. It is not uncommon for price to bounce of an SMA that many traders are looking at and move the other way.
One SMA that can provide these levels is the 200 SMA. The 200, especially on longer time frames, can act as major support or resistance, and often time price will respect it. Now, again, in itself using the 200SMA as an entry strategy will probably be pretty ineffective, but it can certainly be used as an additional area of support or resistance to look out for in your trading.
Here is a perfect example of price respecting the 200SMA on a daily chart:
In the above example, you can see that the 200SMA held as price tried to go lower, but was rebounded to the upside right of the Moving Average.
As you can see, there are a ton of ways that simple moving averages can be used in Forex trading. More often than not, an SMA is just a basic indicator that can serve as an extra bit of info for your trading, or an additional filter for your strategy; but don't forget that it is most often the small filters and additional details that make or break a trading plan!
Thanks for reading, and be sure to leave a comment if you use Moving Averages in your strategy and how you use them.
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P.S. Here is an example, by Casey, of a strategy that uses moving averages:
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