Never miss a story from James Stanley

Subscribe to receive daily updates on publications
Please enter valid First Name
Please fill out this field.
Please enter valid Last Name
Please fill out this field.
Please enter valid email
Please fill out this field.
Please select a country

I’d like to receive information from DailyFX and IG about trading opportunities and their products and services via email.

Please fill out this field.

Your Forecast Is Headed to Your Inbox

But don't just read our analysis - put it to the rest. Your forecast comes with a free demo account from our provider, IG, so you can try out trading with zero risk.

Your demo is preloaded with £10,000 virtual funds, which you can use to trade over 10,000 live global markets.

We'll email you login details shortly.

Learn More about Your Demo

You are subscribed to James Stanley

You can manage your subscriptions by following the link in the footer of each email you will receive

An error occurred submitting your form.
Please try again later.

Talking Points:

  • Traders can use mathematical averaging to their advantage by employing the moving average.
  • Moving averages can be used to initiate positions in the direction of the trend.
  • Traders can incorporate multiple moving averages to fit in their strategy to accomplish specific goals.

Indicators can be tricky tools. Knowing which ones to use and how to use them can be complicated enough; but finding out how to properly employ an entire strategy in the right market environment can be the most difficult question for traders to address.

My colleague Rob Pasche took a look at the Relative Strength Index (RSI) in the article Overbought v/s Oversold and What That Means for Traders, but in the realm of indicators, the most simplistic is probably the moving average.

The Moving Average is simply the last x period’s closing prices added together, and divided by the number of observed periods (x). And it’s in its simplicity lies its beauty. When prices are trending higher, the moving average will reflect this by also moving higher. And when prices are trending lower, these new lower prices will begin to be factored into the moving average and it too will begin moving lower.

While this averaging effect brings on an element of lag, it also allows the trader an ideal way of categorizing trends and trending conditions. In this article, we’re going to discuss three different ways this utilitarian indicator can be employed by the trader.

As a Trend-Filter

Because the moving average does such a great job of identifying the trend, it can be readily used to offer traders a trend-side bias in their strategies. So if price action is above a moving average, only long positions are looked at while price action below the moving average mandates that only short positions are taken.

For this trend-filtering effect, longer-term moving averages generally work better as faster-period settings may be too active for the desired filtering effect. The 200 Day Moving Average is a common example, which is simply the last 200 day’s closing prices added together and divided by 200.

After a bias has been obtained and traders know which direction they want to look to trade in a market, positions can be triggered in a variety of ways. An oscillator such as RSI or CCI can help traders catch retracements by identifying short-term overbought or oversold situations.

In the picture below, we show an example of a CCI (Commodity Channel Index) Entry with the 200 day moving average as a trend filter.

Moving Average as a Trend Filter, CCI as an Entry Trigger

Three Ways to Trade with Moving Averages

Created with Marketscope/Trading Station II; prepared by James Stanley

As a trigger to initiate positions

Taking the idea of strategy development a step further, the logic of the moving average can also be used to actually open new positions.

After all, if price action is showing a trending state just by residing above a moving average, doesn’t logic dictate that the very action of crossing that moving average can have trending connotations as well?

So traders can also use the price/moving average crossover as a trigger into new positions, as shown below.

The Moving Average can also be used to initiate positions in the direction of the trend

Three Ways to Trade with Moving Averages

Created with Marketscope/Trading Station II; prepared by James Stanley

The downside to the moving average trigger is that choppy or trend-less markets can invite sloppy entries as congested prices meander back and forth around a specific MA. So it’s highly suggested to avoid using a moving average trigger in isolation without any other filters or limitations. Doing so could mean massive losses if markets congest or range for prolonged periods of time.

As a Crossover Trigger

The third and final way that moving averages can be implemented is with the moving average crossover. This is an extremely common way of triggering trades, but has the undesired impact of being especially ‘laggy’ by introducing two different lagging indicators rather than just one (as is the case of using the MA as a filter or a trigger individually).

Common examples of moving average crossovers are the 20 and 50 period crossovers, the 20 and 100 period crossover, the 20 and 200 period crossover, and the 50 and 200 period crossover (commonly called ‘the death cross’ when the 50 goes below the 200, or the ‘golden cross’ when the 50 goes above the 200).

The 50 Day/200 Day Moving Average Crossover

Three Ways to Trade with Moving Averages

Created with Marketscope/Trading Station II

This can be taken a step further with multiple time frame analysis. Traders can look to a longer-term chart to use a moving average filter as we had outlined in the (1) part of this article, and then the crossover can be used as a trigger in the direction of the trend on the shorter time frame.

While no indicator is going to be perfect, these three methods show the utility that can be brought to the table with the moving average, and how easily traders can use this versatile tool to trigger trades ahead and in front of very large, outsized moves in the market.

--- Written by James Stanley

James is available on Twitter @JStanleyFX

To join James Stanley’s distribution list, please click here.

Would you like to enhance your FX Education? DailyFX has recently launched DailyFX University; which is completely free to any and all traders!

DailyFX University