The Moving Average Crossover is a valuable tool to find the middle price-point of a trend in forex trading. When currency prices crossover their current moving averages, it helps traders identify the favorable buying or selling points for the currency.
Since new traders are beginners and do not have much knowledge about the forex market, it gives them a solid basis for their trading strategy. In this article, we will discuss everything there is to know about moving average crossover, and more.
The moving average crossover occurs when we plot two moving averages based on different timeframes (long-term and short-term), which end up crossing up each other on a particular point.
There are two averages that we consider in this strategy:
Short-term moving average is the average price of the currency over a span of less than a year and it is also the faster-moving average
Long-term moving average is the average price of the currency over a span of a year or more, and it is also the slower moving average.
The reason behind the short-term moving average is faster is because it considers prices only at a short interval, hence the volatility is higher. On the other hand, the long-term moving average is slower because it considers prices over a long period of time and is less reactive to daily prices.
If the short-term moving average exceeds or crosses the long-term moving average from above, it is an indication for traders to buy the currency. But if the short-term moving average crosses the long-term moving averages from below, it is an indication to short the position and sell the currency due to the downward trend.
Also known as a double moving average crossover, it is a trend indicator that identifies support and resistance levels. At a support level, the falling prices stop falling and change their direction to finally rise. In contrast, at the resistance level, the rising prices stop rising and begin to fall instead.
Moving averages is the long-term moving average can be of two types:
The simple moving average: It is calculated by adding the closing price of the currencies and dividing it by the number of periods in the range. It gives the average price of the currency over a particular period of time.
The exponential moving average: It places a greater weight on the most recent currency prices. It is used to derive buy and sell points based on crossovers.
The moving average trading strategy that we will be discussing uses the exponential moving average. We consider this because the exponential moving average responds quickly to all the price changes. Follow the steps for developing a successful moving average trading strategy :
Plot three moving averages over 3 different periods. Let us consider 5-period, 20-period, and 50-period exponential moving averages on a 15-minute forex chart.
Enter the market or buy the currency when the 5-period exponential moving average crosses the 20-period exponential moving average from below. Both the 5-period and 20-period exponential moving averages prices should be above the 50-period exponential moving average prices.
If you wish to identify the selling point or the point to exit the market, only sell when the 5-period exponential moving average crosses the 20-period exponential moving average from above. Both the exponential moving averages and the price of the 5-period and 20-period exponential moving averages should be below the 50-period exponential moving average at this point.
Ensure that you place a stop-loss order below the 20-period exponential moving average during a buy move.
You can also move this stop-loss point to a break-even point when the trade becomes 10% more profitable.
You can set a profit target of 20% and/or exit when the 5-period exponential moving average line is below the 20-period exponential moving average line.
One of the most traded moving average strategies is the Moving Average Envelopes Trading Strategy. These are percentage-based envelopes that are set below and above a particular moving average. Both simple moving average and exponential moving average can be used as the basis of the moving average. However, the exponential moving average is considered a more relevant moving average that presents better results as it reacts more dynamically to the prices.
In this trading strategy, forex traders test different percentages, timeframes, and currency pairs in order to understand how one can make the best use of the strategy. Mostly, envelopes are seen over 10 to 100 day timeframes and are 1-10% away from the moving average.
During day trading, envelopes are often lesser than 1%. The percentages change daily depending on the market volatility.
Traders should ideally trade when they see a strong overall direction bias to the price, either as an upward or downward trend. Most traders then, only trade in that particular direction. In case of an uptrend, traders should consider buying more as the price approaches the moving average point. Whereas, in a downtrend, traders should short-sell their positions as the price reaches the moving average point and then, drops further. Once the traders short the position, they should place a stop-loss order just above the recent high price point. In case of a long-trade, a stop-loss order should be placed just below the recent low price point.
As soon as the price reaches the lower point on a short trade or the upper point on a long trade, traders should consider exiting the trade to minimize losses. Lastly, it is a good strategy to set targets double the risk. For example, if you risk 5%, set a target of a point that is at least 10% away from the entry point.
The Three Drive pattern depends both on price and time. However, since it is a rare trend to occur, traders should not force themselves to identify it. If the traders do not see it in a chart, it is simply best not to trade it at all.
It tells the traders about the market reversal, which occurs after the completion of the third drive. However, some conservative traders look for more confirmation about the price reversal. The targets can be set according to their wish but are generally best suited when placed beyond the last retracement level, as shown by the three drive pattern.
The pattern’s non-availability results into a continuation in the previously dominant movement, implying that if the market has been continuously falling, it is more likely that the prices will keep declining. On the other hand, if the prices have previously been increasing, and there is no three drive pattern in the chart, more chances are that the prices will keep on increasing.
Moving average crossovers are extremely helpful for forex traders. However, in a consolidating market, moving average crossovers give various false signals. It can produce several signals that do not really indicate any trend in particular. It also implies that during such a situation, a trade does not experience an upward or downward bias in the currency pair, which could have led to significant profits.
Moving average crossovers offer triggers for potential entry and exit points and is one of the most straightforward trading strategies that a trader can follow.
However, these triggers should always be confirmed and backed by chart patterns to ensure that the average moving crossover does not send any false signal.
Blueberry Markets is a forex trading platform that offers you relevant information and graphical representation about the currency's price trends, enabling you to place successful trades and profit from them.
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