How to identify trends with moving average, whether we can use a moving average to determine the trend?
Of course, the answer is yes.
Because one of the uses of the Moving Average is to identify the direction of the trend.
If the price moves uptrend, the MA line will move up, and vice versa when the price movement is downtrend, the MA line will move down.
Well, we will learn about this chapter after in the previous chapter we have studied and made a comparison between simple vs the exponential moving average.
This indicator is simplest if compared with another indicator.
How to calculate it from the sum of closing prices for a certain period, then divided by the total time in that period.
Moving Average is included in the repainting indicator or lagging indicator, so there are weaknesses to predict prices accurately.
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How to use the Moving average to find the trend?
Read also Trend lines forex, what are trend lines?
One of the sweetest functions of the moving average indicator is to identify market trends.
How do I read the moving average indicator to identify trends?
As the name implies, this is actually very simple, when prices are above the MA line, this is an uptrend.
Conversely, if the price is below the MA line, then this is an indication of a downtrend, is that simple?
Take a look at the image below
How to identify trend with moving average
The image above shows the USDJPY pair on a daily timeframe, using a simple moving average with a period setting of 10.
Of course, you still remember how to calculate SMA, well by calculating closing prices for the past 10 days.
In theory, when prices are above the SMA line, this is an uptrend, but we can see that prices are not always above the SMA line, and sometimes crossing the SMA line.
This condition makes the use of SMA not as simple as theory.
But to further simplify the use of this simple moving average, we can make trading rules that will only open positions in the direction of the trend line formed, for example in the example above that the MA trend shows an uptrend.
To open a buy position it will be a lower risk if the price is above the SMA line, by searching for the area closest to that line.
Conversely, if the condition of the downtrend, will only open a position when the price is below the SMA line and look for the closest to the line.
Moving average is simple but not simpler
In theory, if the price crosses this moving average line it will be a sign of a reversal, so when a long candlestick appears across the moving average line, you might think it’s time to open a position.
But wait, the conditions are not that simple, let’s take an example.
Below is an image of USDJPY that is in a downtrend
In this example, the market is in a downtrend, and you see one candlestick crossing the MA line from the bottom up.
Maybe you will think that this is a sign of reversal because the price rises up, and it’s time to open buy.
But take a look that it turns out that the price movement spike is caused by the presence of high impact news that makes prices surge and crosses the moving average line.
If you really make the decision to open buy in this condition, with the reason that the Morubozu candlestick pattern appears across the MA line, then you will face a bad condition because you will find your order floating loss.
See what happens next turns out that spike movement is only a temporary influence of high impact news and price movements back into a further downward trend.
It turns out you’re stuck with the appearance of fake signals, and maybe you will regret this recently because you have entered too confidently using a large position size.
How to minimize fake signal moving average?
Finding a fake signal is something that is not expected, but this sometimes appears in some conditions like the case above because the news has a temporary effect.
Then how to minimize the occurrence of fake signals with moving averages?
Some traders plot not only one moving average, but they use two moving averages using different periods.
This gives us a clearer signal of whether the pair is still experiencing an uptrend or downtrend, depending on the moving average.
In the uptrend condition, using shorter moving average periods must be above the moving average lines that use longer periods, and vice versa for a downtrend.
For example, we use MA with periods of 20 and MA with periods of 10, to easier we called “faster MA” and “slower MA”
The above image is a daily chart of USD / JPY. In an uptrend, SMA 10 (faster MA) will be above SMA 20 (slower MA)
As you can see, we can use a moving average to indicate whether a pair is in an uptrend or downtrend.
The combination of MA indicators and our knowledge of trend lines will help us determine position.
Do we have to place short-position or long-position?
We can also try using more than two moving averages on the graph.
Some traders even use more than ten moving averages with different line colors so they form like the colors of the rainbow.
As long as the lines match the order.
Faster lines to slower on the uptrend, slower lines to faster on the downtrend, thus we can ascertain whether our target pair is in the uptrend or downtrend.
Advantage and disadvantage using two moving average
- + Signals that are given are a lower risk from the occurrence of fake signals
- + You will be less likely to open a position to get a signal according to the rules of the two MA lines.
- + The more rarely open a position the more minimal risk.
- – The resulting signal may be slower and lagging
- – You may need to place a wider stop loss distance to give room for price movements.
- – With a wide stop loss the possibility of greater risk in a trading plan.
How to identify trend with moving average
Using a moving average indicator to identify trends, it is better to not only use one moving average but using two moving averages will provide clearer conditions for measuring trends.
But indeed, in reality, you might face different conditions from the theory, therefore you should be advised and not too confident with the signal from the moving average.
Remember that price movement in the market is not mathematical calculations that provide fixed value.
To get a better experience you can improvise by using a combination of several moving averages.
And don’t forget money management, because with this you will be better able to maintain your account when the indicator does not give a definite signal.
To calculate the position size that suits your capital, you can use the position size calculator indicator to make it easier.
Along with your experience, you will provide a better understanding of the character of the moving average indicator.
And more, you will better follow news updates because sometimes giving a sudden impact on the currency.
As a final word, we will continue the next chapter on how to use moving average crossovers, stick with tenkofx.co.za