Direct from the desk of Dane Williams.
While I prefer to trade pure price action, having a keen understanding of various indicators will still make you a better trader.
Put frankly, moving averages, otherwise known simply as MAs, stand out as indispensable tools that all traders should be familiar with.
For that reason, let’s today unravel some of the mystery behind the two most common moving averages:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
The 2 most common MAs in forex
Simple Moving Average (SMA)
The Simple Moving Average (SMA) is the most simple of this popular indicator.
The SMA calculates the average price of your currency pair over a predetermined period, providing a smoothed out representation of market movements.
Yes, an average.
The beauty of the SMA lies in its brevity, effectively filtering out short term price fluctuations and allowing you to discern prevailing trends with clarity.
Often employed by both novice and seasoned traders, even if just sitting in the background of all your charts, SMAs serve as reliable tools for identifying potential reversal points or validating existing market trends.
Exponential Moving Average (EMA)
Now, let's shift focus to the Exponential Moving Average (EMA), the more relevant and dynamic sibling to your humble SMA.
Unlike its counterpart, the EMA places greater emphasis on recent price data before publishing its smooth representation.
This unique characteristic renders the EMA more responsive to rapid market changes, offering you a more nuanced perspective on freshly evolving trends.
If you seek a more immediate interpretation of market sentiment, the EMA's ability to adapt swiftly to shifting conditions are what you’re looking for.
It all depends on your trading strategy and how you intend to use MAs.
Simple MA crossover trading strategy
One popular strategy that involves either of the two common moving averages I’ve listed above, is the Simple MA crossover.
All you need on your charts to trade this strategy is a longer term SMA and a shorter term SMA.
Once you’re more comfortable with the strategy you can play with the periods, but to start with I’d encourage you to use the popular 50 day SMA and 200 day SMA combo.
When the short term SMA crosses above the long term SMA, it signals a potential uptrend, thus giving you a buy signal.
Conversely, if the short term SMA crosses below the long-term SMA, it suggests a possible downtrend, prompting a short signal.
This strategy is a powerful yet straightforward tool in a trader's arsenal, offering a systematic approach to interpreting market movements.
The issue with any moving average crossover strategy is of course that it throws up a lot of false signals.
Used alone, they’re too messy.
But combined with a discretionary price action strategy, they can be extremely powerful.
Final thoughts on moving averages in forex
Finishing up, mastering the art of moving averages should be seen as just another arrow in your arsenal.
The Simple Moving Average (SMA) and the Exponential Moving Average (EMA), can certainly help you identify the early development of new trends and thus help you milk a bit more out of each trade.
For the best results, I’d encourage you to keep these moving averages in mind and use them as part of a more complex discretionary trading strategy.
Best of probabilities to you.