One sweet way to use moving averages is to help you determine the trend.
The simplest way is to just plot a single moving average on the chart. When price action tends to stay above the moving average, it signals that price is in a general uptrend.
If price action tends to stay below the moving average, then it indicates that it is in a downtrend.
The problem with this is that it’s too simplistic.
Let’s say that USD/JPY has been in a downtrend, but a news report comes out causing it to surge higher.
You see that the price is now above the moving average. You think to yourself:
“Hmmm… It looks like this pair is about to shift direction. Time to buy this sucker!”
So you do just that. You buy a billion units cause you’re confident that USD/JPY is going to go up.
Bammm! You get faked out! As it turns out, traders just reacted to the news but the trend continued and price kept heading lower!
What some traders do – and what we suggest you do as well – is that they plot a couple of moving averages on their charts instead of just one. This gives them a clearer signal of whether the pair is trending up or down depending on the order of the moving averages. Let us explain.
In an uptrend, the “faster” moving average should be above the “slower” moving average and for a downtrend, vice versa. For example, let’s say we have two MAs: the 10-period MA and the 20-period MA. On your chart, it would look like this:
Above is a daily chart of USD/JPY. Throughout the uptrend, the 10 SMA is above the 20 SMA. As you can see, you can use moving averages to help show whether a pair is trending up or down. Combining this with your knowledge on trend lines, this can help you decide whether to go long or short a currency.
You can also try putting more than two moving averages on your chart. Just as long as lines are in order (fastest to slowest in an uptrend, slowest to fastest in a downtrend), then you can tell whether the pair is in an uptrend or in a downtrend.