Moving Average Trading Strategy Guide
The moving average is likely to be one of the first indicators you’ll experiment with when learning how to trade. However, far from being just for beginners, the moving average is an important and versatile indicator which can be used to identify trends.
In our moving average strategy guide, we will examine how this popular indicator can be used by traders to create a variety of trading strategies.
The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.
What Is the Moving Average Indicator?
A Moving Average (MA) is a mean average which is continuously calculated over a specified time period for a data set.
The “moving” part of the name is there because a new value is calculated as the time frame advances, so that the value of the average is continuously adjusting to reflect changes in price.
The result is a versatile technical indicator, which can help traders identify the direction of a trend and is used by many traders as part of a wider trading strategy.
Moving Average Strategies
In the following sections, we’ll take a look at three examples of moving average trading strategies, to demonstrate how the indicator can be used by traders. Please note that these examples have not been tested in live conditions.
We will look at a combination of Simple Moving Averages (SMAs) and Exponential Moving Averages (EMAs) but, at the end of the day, the most suitable type of moving average indicator will depend largely on the trader in question. The same goes for the lookback period chosen for calculating the moving average.
As EMAs give greater weight to the most recent price data, they tend to be quicker to respond to changes in price. This can result in a higher frequency of trading signals but could also increase the number of false ones.
Moving Average Crossover Strategy
The first strategy we’ll examine is known as the moving average crossover strategy. This strategy uses two moving averages, which can indicate a potential change in trend whenever a shorter-term (faster) moving average crosses over a longer-term (slower) moving average.
As we briefly mentioned earlier, the ideal period chosen for the moving averages will depend largely on the trader in question.
Short-term traders may prefer using shorter periods for both indicators, whereas longer-term traders may prefer longer lookback periods. Shorter-term MAs will tend to produce more signals, whereas longer-term MAs will produce less.
As an example, we have added a 20-period SMA in black and a 50-period SMA in red to the daily EURUSD chart below.
Whenever the faster, black, SMA crosses above the slower, red, SMA it may indicate a bullish (buy) signal. Conversely, when the black SMA crosses below the red SMA, it may indicate a bearish (sell) signal.
In the chart above, we have highlighted the three instances when the faster SMA crosses the slower SMA. In these three instances, the crossovers signalled the start of a new trend.
However, you will note that as the price begins to move sideways there are a couple of crossovers which turn out to be false signals (it’s too early to tell from the chart above whether the most recent one is or not).
This highlights a risk of moving average crossover strategies, which is that they can produce a lot of false signals, particularly when the market starts moving sideways.
Triple Moving Average Strategy
As the name suggests, this moving average trading strategy uses three MAs: one fast, one medium and one slow.
The logic is similar to the previous crossover strategy we looked at, but traders only focus on set ups that align with the trend. The slowest MA acts as a trend filter and, consequently, signals are only generated when the two faster moving averages are on the correct side of this filter.
This time we’ll use Exponential Moving Averages in our example. In the daily EURUSD chart below, we’ve added a 10-period black EMA, a 20-period red EMA and a 50-period blue EMA.
We’ve highlighted an example of where a bullish signal was generated.
The black and red EMAs and the price are all above the 50-period EMA (our filter), indicating that the market is currently in an uptrend.As the black EMA crosses back above the slower red EMA, it might be interpreted by some traders as a bullish signal.
Moving Average Ribbon Strategy
A moving average ribbon is a collection of MAs (usually between 6 and 16) with a variety of different time periods which are plotted on the same chart.
The MAs vary in length from short-term to long-term and the resulting ribbon-like effect provides traders with an indication of both the trend direction and its strength.
When the MAs are parallel and evenly spaced this means that the current trend is strong.
An expansion between the ribbons can indicate the current trend may have peaked and could be coming to an end. When the ribbons begin to contract and move closer to one another, it can indicate that the trend is changing direction.
As with other moving average strategies, traders can use crossovers to generate buy and sell signals. However - due to the number of MAs and, therefore, crossovers involved - each trader can decide for themselves how many crossovers indicate a suitable signal for their strategy.
To illustrate, we have added 10 EMAs to the GBPUSD daily chart below with the following periods: 10, 20, 30, 40, 50, 60, 70, 80, 90 and 100.
Final Thoughts
In this guide, we’ve highlighted three different examples of moving average trading strategies, to demonstrate how traders can integrate this indicator into their trading. But remember, the strategies we have looked at are just examples.
When trading with the moving average indicator, different settings and combinations might be more appropriate for different types of traders and their individual trading style. In order to work out suitable approaches, a demo trading account can be a good place to experiment.
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Frequently Asked Questions
Do moving average crossovers work?
Moving average crossovers can be used by traders to identify a potential change in trend. However, not every crossover will result in a new trend being formed. Particularly in volatile or sideways moving markets, a moving average crossover strategy can generate false signals.
What is the 5-8-13 EMA strategy?
This is an example of a triple moving average strategy, where three Exponential Moving Averages (EMAs) are plotted on a price chart. In this example, periods of 5, 8 and 13 are used for the EMAs (the settings are derived from Fibonacci numbers).
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