Today we will be talking about the most popular trend indicator: Moving Averages (abbreviation MA).
The Moving Average Indicator is especially popular for its simplicity and robustness – we can use it on any instrument, from stocks, forex, indices to futures, commodities and more. Popularity grows further with the possibility of wide parameter settings.
Definition of the Moving Average Indicator
Many traders I know have this MA indicator incorporated in their trading strategy and they can tell many compliments about it. Each of them uses different settings.
Types of Moving Averages
SMA – Simple Moving Average
Simple Moving Average is the MA´s simplest version. For the SMA calculation is used following simple arithmetic mean:
SMA = (P1 + P2 + … Pn) / n
Pn = closing price of n-interval of trading days
n = number of days used for the moving average
EMA – Exponential Moving Average
The exponential moving average is generally more popular, mainly due to the fact that the moving average line gives greater value to the latest prices and is able to trace trend changes quickly.
EMA = (Pn * Exp) + (P(n-1) * 1-Exp)
Exp = 2/(n+1)
Pn = price of the candle in the chart
n = period
How to trade with Moving Average Indicator?
1 # Trend direction determination
Most often it id traded when two different SMA or EMA are crossing. The advantage is that the moving averages can be combined. SMA 100 on the EURUSD market when using one hour timeframe looks as follows:
The moving average works very well also as a support or resistance when traders can speculate on the reflection from the moving average line.
2 # Support and Resistance
In addition to determining the direction of trend, the indicator will also help you when entering to the trend (on corrections) and also to determine the stop loss.
3 # Chop filtering
Unfortunately markets do not move only in trends, but they mainly stay in the chop. Chop is the situation where the market is hesitating in which direction it will move. Often it seems like a complete chaos in which it is almost impossible to trade. And because we can make most money in trending markets, moving averages will help us identify and filter the chop situations.
Ideal setting of Moving Averages for swing trading
Trading in higher timeframes brings several advantages to traders. The key benefits are:
- chaos and very rapid trend changes at a lower timeframes are filtered out
- the trend takes few days, on the smaller timeframe it usually takes few hours
- compare to lower timeframes, moving averages have greater value on support and resistance levels
Now to the actual setting of the period:
- Period 21: Probably my favorite settings, suitable for short-term swing trading. During the trading, the price respects the line of the moving averages and it works here as a support or resistance level under a strong trend. Also it better identifies a strong change in the trend.
- Period 50: Ideal for medium-term trading, such a golden way and compromise.
- Period 100: This setting works perfectly as support and resistance, it is ideal for both daily and weekly timeframes.
- Period 200/250: The same applies for the 250 period moving average. Usually, one trading year has 250 days, this period is particularly suitable for trades you want to keep for several years. It is therefore ideal for stock markets and long term stock holding.
Moving averages work on a very similar principle as the Bollinger bands, so you can expect another article, describing and showing the Bollinger bands and how to trade with them.