Home / Forex Trading Lessons / Dangers Of Moving Average Trading Strategy

Dangers Of Moving Average Trading Strategy

The reason why are moving average trading methods so well-liked?

Moving averages tend to be popular simply because they smooth away price “noise” along with a quick take a look at a chart may show which trading the actual moving average crossover is an efficient trading strategy.

Or is it?


WHAT IS A MOVING AVERAGE?  A very popular  technical indicator showing the average value of  of a particular currency price over a set period of time.


The actual keywords tend to be average worth and price meaning moving averages require price to be able to calculate a good output. This is among the biggest disadvantages of moving averages or almost any trading indicator – these people lag cost

Price techniques first and also the indicator techniques second that, if you’re mechanically utilizing a moving average trading strategy, will also have you late towards the trade.

4 MAIN TYPES OF MOVING AVERAGES

Virtually all chart packages for Forex, Futures, Stocks or any other market will have the moving average indicator.  There are 4 widely used moving averages:

Simple Moving Average

Probably the most commonly used kind of moving average, the easy moving average (SMA) is actually calculated with the addition of and after that averaging some numbers representing the marketplace. The SMA is undoubtedly the popular mode, which is considered extremely useful due to the smoothing impact.

The SMA stresses smoothness, that’s, it attempts to lessen the inconsistent behavior from the market to be able to see the actual trend. Nevertheless, there are people who don’t like the proven fact that the SMA lags behind the most recent data point naturally of it’s smoothing, plus they prefer to provide more pounds to newer data factors, as within the weighted moving average (WMA) as well as exponential moving averages (EMA).

Exponential Moving Average

The actual Exponential Moving Average (EMA) is actually calculated with the addition of the moving average from the trading instrument from the current shutting price towards the previous worth. Exponential moving averages allocate more meaning towards the recent costs and less towards the closing price in the period’s starting. Thus it’s faster from detecting the trend change.

Naturally, and with respect to the length, it may be more susceptible to marketplace noise which can lead to traders obtaining caught within whipsaws.

Smoothed Moving Average

A Smoothed Moving Average is sort of a blend between a Simple Moving Average and an Exponential Moving Average, only with a longer period applied (approximately, half the EMA period: e.g. a 20-period SMMA is almost equal to a 40-period EMA)

Linear Weighted Moving Average

Calculated by multiplying each one of the closing prices within the considered series, by a certain weight coefficient. Like the EMA, the LWMA assigns more meaning to the recent prices and less to the closing price from the period’s beginning. Thus they are faster at detecting a trend reversal, though it they can be more prone to market noise.


Warning:  Do not get caught up and waste your time in deciding which is the best moving average to use.  There is no best.  I can tell you that most traders I know use the simple moving average (SMA) because they use the moving average as a guide –  not in deciding to make a trade.


Here is an example of the different moving averages applied to a chart.

Moving Average Trading Strategy

I think you can see the on a macro level, there is not much different between any of the averages.

How To Use Moving Averages

Moving averages are a terrific way to determine the actual trend direction of the instrument. Whilst price motion and framework is my personal preferred method, you could possibly get a general concept of the marketplace direction having a moving average.

You should use the slope from the moving average: up sloping is definitely an uptrend as well as down sloping is actually downtrend.

You should use price area: if cost above moving average, search for long deals. Below the actual average you’d look with regard to short possibilities.

  • Fast line crosses over to the upside = uptrend
  • Fast line crosses over to the downside = downtrend

trend

This can be a 20 time period simple moving average (SMA) and also the arrows emphasize the trend direction obtained from the slope from the moving average. The yellow-colored lines indicate in which the moving average is actually flat which may have a person not getting any trades should you were utilizing slope because your trend path.

You can easily see that cost can mix the moving average after which fall on the other hand. This is actually where while using moving average because your only method of trading is actually dangerous. Always allow just a little “splash” round the moving average.

Moving averages will help you with mean reversion which means pullback trading.  Believe it or not, there is an edge in trading pullbacks as long as you don’t believe that support and resistance happens with a moving average.  It doesn’t.

trend

With this particular simple trading strategy, we are searching to trade pullbacks in the region around the actual 20 SMA as well as looking with regard to previous framework.

All the actual highlighted areas show cost pulling to the moving average but additionally to prior chart framework. The trade entry is merely entering the actual trade below the reduced or over the a lot of the last pullback candlestick.

You may also use a cost action admittance strategy to make the most of these trade areas.

This is a perfect example and they will not always look like that.

ugly

This chart shows how messy trading can get.  Once you see price whipping back and forth over the moving average (EMA, SMA – doesn’t matter), you are looking at a chart in chop.

The actual green superstars show the down trending pattern associated with lower levels and reduce highs. The red-colored X shows in which the price pattern stops working and when the red By level isn’t taken away, you might want to also remain aside since the market is actually appearing to create a variety.

Moving Average Strategy

While the trend change is problematic if using price placement, you can use those zones for pullback trades and you can see on this chart they did pretty well.

The lag time of the moving average is clear when price moves 400 pips to the downside before showing a trend change although price action trades would read that momentum as a break in trend.

The moving average has price whipping back and forth and that is a market in a range and something you do not want to trade.

Can You Fix The Problems With Moving Averages?

One of the best ways to fix an issue with any technical indicator is to have a strong understanding of price action and certain chart patterns.  Make sure you read my entire swing trading strategies blog – it’s all free!

MOVING AVERAGE TRADING PROBLEM #1: LAG

Moving average is a trend following indicator. It can only tell you when the trend has already happened. You can’t forecast a new trend with a moving average because its a lagging indicator.

You will notice that in the chart above the moving average was still rising whilst price hit the resistance level at around 1.4911 and went down by 400 pips plus.

FIX: Reduce the length (number regarding day etc) inside the moving averages. This may make that more tuned in to price movement as the shorter moving average will be more tuned in to price movements. Or work with a more reactive moving average just like the exponential moving average (EMA) or perhaps liner weighted moving average. There exists a trade-off using a faster moving average – faster a reaction to price modify = more potential for whipsaw.

MOVING AVERAGE TRADING PROBLEM #2: NOISE

Among the best things regarding using moving averages with regard to trading is actually that moving averages are made to smooth away the inconsistent price data to be able to be in a position to detect the actual trend and stick with the trend. Nevertheless, even the very best moving averages are afflicted by noise. This happens once the market offers volatile cost spikes as well as short phrase corrections which can help to make price escape from the containment part of the moving average.

FIX: Here are a few options. Apply much more days/periods towards the moving average and caused by this is it smooths this out and allow it to be less responsive for instance: instead of utilizing a 25 easy moving average, you should use a 50 easy moving average. Opt in order to using easy or smoothed moving averages…this enables you to reduce the actual noise.

Big disadvantage – if you are using the moving average like a stand on it’s own trading strategy you’ll be late the each and every trade. You might be entering, as with the instance, over four hundred pips past due just once the market might be looking in order to bounce.

MOVING AVERAGE TRADING PROBLEM# 3: SIDEWAYS MARKET

There is nothing so irritating than trying to utilize a trend trading strategy inside a sideways marketplace! Your cease losses don’t stand an opportunity! Regardless of which kind of moving average you utilize in the sideways marketplace, they won’t work successfully. There is going to be too numerous false indicators.

You tend to be better associated with using variety trading strategies rather than moving average trading strategies throughout a sideways marketplace. The problem along with sideways marketplace is you are able to never know without a doubt until it’s happening. You can’t predict it ahead of time.

FIX:  Among the best ways to maintain out associated with trading sideways marketplace is knowing what type of period you’re trading within. If you realize that it’s a vacation period the big bucks traders tend to be on vacations, then obviously you will see less quantity and volatility on the market so the marketplace will maintain sideways setting.

Or should you don’t understand, the Hard anodized cookware Forex trading program also tends be considered a sideways marketplace but begins to trend once the London program opens which trend usually continues to the US Forex trading program. So understanding this types of information can help you in keeping away from the marketplaces as there’s potential with regard to sideways motion.

Please Share, If you find it useful.

 

Check Also

Forex Trading Strategy using Daily Fibonacci Pivot

The actual Daily Fibonacci Pivot Strategy utilizes standard Fibonacci retracements within confluence using the daily …

Leave a Reply

Your email address will not be published. Required fields are marked *