UNDERSTANDING MOVING AVERAGE

Hello traders! 👋 🤗 Today I will try to explain to you guys another perspective and the concept of moving average. This is one of the oldest technical indicators and, perhaps, the most popular and most frequently used, as a huge number of other indicators are based on it. A lot has been written about moving averages. And at the same time, despite the abundance of information and respect for this instrument on the part of almost all traders, the issue of trading on MA is poorly covered. What do we often see about moving averages? Most of it is crossover. When one sacred line crosses another, we should enter the trade or something like that. I would like to show one simple method of working with moving averages.


A few important points
Only Simple Moving Average (MA) on closings is used. When working with moving averages, only 2 parameters are important: PERIOD AND SLOPE ANGLE. Any crossings and other things are not taken into account. Only MAs with a high period (from 100 and above) are used.

Thus, we can see the general direction, which looks a bit smoother and more obvious than a regular chart. In general, it is considered that if the price is above the moving average, it is an upward trend; if it is below the moving average, it is a downward trend. At the same time, the higher the period of the moving average, the more long-term the trend is. For example, with a moving average period of 21, we can say that if the price is above it, it is a rather short-term upward trend.

If the moving average period is much bigger, say 100, and the price is above the moving average with a period of 100, then we can say that there is a solid upward trend. If the price is below the moving average with a longer period (for example, 100), then we realize that there is a solid downward trend.

In other words, the longer the period of the moving average, the more inflexible it is because it has to calculate the average value for the last candles (in our case, 100). This is a lot. And, accordingly, the longer the moving average period, the more important it is in the long term. Our job as traders is to squeeze everything out of the movement. The least job is to stay at breakeven and don’t blow the account. That is why large MA periods are used. And do not believe the words when they say that MAs are lagging.

For the demonstration we will use 3 timeframes: 4 hoursly - 1 daily - 1 weekly. As practice shows, the approach described below works even in the combination of 5 minutes - 15 minutes - 1 hour. This for day traders.

Examples of moving averages
As an example, we will now show the chart of one asset from 3 timeframes as already mentioned above:

Weekly (MA 100) will show us the direction of the global trend
Dayly (MA 200) the medium-term trend
4-hourly (MA 100) the actual entry points and setting Stop loss and Take profit

The essence of working with big MAs is very simple: we can trade only in the direction of MA movement, and at the entry point, the price should be on one side of all MAs (above or below it) on all 3 timeframes. In this case, the mandatory condition is that the angle of slope of the MA of the highest period must be strong, approximately 45 degrees.

AUDCHF weekly
Go down to the daily timeframe and apply MA 200. We highlight the areas where the price is also below the MA 200 on the daily timeframe. We also take into account the slope angle of the current MA. We highlight this movement with a green block.

AUDCHF daily

AUDCHF 4H
Now we go to H4 and apply MA 100. This is the timeframe for a possible entry point. We select the block where the price is below the MA on the current timeframe. We cut off all the moments when the price was above the MA, highlight the price movement below the MA with yellow blocks

3 potential areas where we can look for entry points to open short positions. Let's take a closer look at each area.

First opportunity

Second opportunity

Third opportunity
Of course, on live trading, things would be much more difficult. But as you can see, we got at least two very clean trades that screamed to take them.

Another one
EURJPY weekly

EURJPY daily

EURJPY 4H

Closer look
Again in hindsight everything looks good, but the purpose of this post is to help you build and understand a slightly different method of applying moving averages if you use them. As you can see, trend trading is actually much easier.

What about sideways movements?
If the trend is more or less clear, and as soon as the SMA on the higher timeframe (say, daily) shows a more flat angle of slope for the last 5–10 bars, we have a sideways movement. You can try to take advantage of this on the lower timeframes. 

In this post I tried to show how to systematize and demonstrate my approach to trading on moving averages. Of course, there are many methods of trading on short-term moving averages, on the combination of multi-period MAs on one chart, etc. Sometimes it is hard to describe in words what is "right" angle of slope, and the overall price movement, I guess all this comes only with personal experience.

Traders, If you liked this educational post🎓, give it a boost 🚀 and drop a comment