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The Moving Average Trade

The Moving Average Trade

Thomas Long, Course Instructor

Trading with the trend is more than just a cliché; it is an important edge that we want to use in every trading decision.  But identifying the trend can be tricky for the new trader.   Some markets seem to offer an optical illusion rather than a clear picture about its direction.  This is where the most popular technical indicator comes into play.  The daily chart with a 200-day Simple Moving Average plotted on it may be the most watched combination in all financial markets.  When working with a number of markets on a daily basis, traders need some way to be able to recognize a strong trending move easily.  This daily chart of the EUR/USD shows how this moving average is used for this task. 

eurusd  movavg

If the market is above the moving average, the trend is up.  In this environment, many experienced traders look to buy any weakness.  This is commonly referred to as “buying the dips”.  If the market is below the moving average, the trend is down.  In this environment, those same traders look to sell strength.  This is commonly referred to as “selling the rallies”. 

Between May of 2009 and December of 2009, we see that the EUR/USD was above the 200-day Simple Moving Average.  Traders were looking to buy weakness in anticipation of the market moving up to a new high and that happened more often than not.  We currently see that this pair is below the 200-day Simple Moving Average and is moving down.  Now traders are looking to sell any rallies in anticipation of the market moving down to a new low. 

While experienced traders have an approach that identifies a good chance of a reversal when buying the dips or selling the rallies, new traders often do not.  This is when the simple breakout approach can be of value.  Instead of buying the dips, you simply buy on a break up to a new high.  On the flip side, instead of selling the rallies, you simply sell on a break down to a new low.  An example can be seen on our chart above.  The EUR/USD is in a downtrend since it is below the 200-day Simple Moving Average.  We also see a move up off of the recent low.  When/if the market moves down through that 1.3422 low, the breakout trader will sell in anticipation of more selling pressure.  This simple approach to trading, when used with a solid money management strategy, can be effective in identifying solid trading opportunities on any time frame chart.  However, it is the daily chart that can best offer the chance to be in on the long trending moves that the FX markets are known for.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.