One of the reasons why traders come to the Forex market is to chase trends. Trend trading is simple, rewarding, and thus appeals to all kinds of traders.
But the problem with trend trading is that the market spends a lot of time in consolidation. It takes its time in ranges, and traders pay a dear price for not having enough patience to let the trend run.
To deal with the lack of patience, traders use trend indicators designed to keep them on the right side of the market. The most popular and influential, trend indicator is the moving average.
Depending on its formula, multiple types of moving averages exist. The most famous one, the SMA (Simple Moving Average), just averages the closing prices of the last periods to plot the moving average on a chart.
Support and Resistance with Moving Averages
The main way to use a moving average is to look for a reaction when the price comes to it. A moving average that considers few periods is called a “fast” moving average, while one that averages the prices for multiple periods is called a “slow” moving average.
Naturally, the slow-moving averages offer stronger support or resistance when the price reaches them. However, the more the price has the power to reach the moving average, the weaker the support or resistance becomes.
The chart above shows the recent EURUSD price action. Both the timeframe and the periods considered for the two moving averages are big enough for the resistance or support to be significant.
In this case, the blue moving average uses the 50-period, while the black one is the famous 200-period SMA. Their crossing shows bullish and bearish conditions, with traders looking to buy dips or sell spikes.
When the SMA(50) crosses above the SMA(200), the market forms a golden cross. It shows a bullish environment and a visible rising market. Apparently, traders use it as a sign to buy dips into the moving average.
A bearish cross, or a death cross, forms when the SMA(50) moves below the SMA(200). Traders look to fade any rally into the two MA’s, having in mind, though, that the more the price hits the averages, the weaker the trend becomes.
Trend trading with moving averages has the advantage of offering dynamic support and resistance. Not only that the averages offer support or resistance, but they follow the price as it trends higher or lower.
This way, they give traders the opportunity of adjusting the stop-loss or take profit to take advantage of all market moves.