Lesson 14: Using Moving Averages to Confirm Trends and Find Signals

Moving averages are also one of the most widely used tools in technical analysis.

Concretely, these are curves resulting from calculations of sliding averages of prices. For example, to calculate a 20-Week Average, we calculate the weighted average of the last 20 closing prices for each period, which gives us a price.

In order to calculate the following price, this average is corrected by taking the closing price of the last candle (the 21st) and excluding the price of the first candle (the first) and so on.

It may be a bit blurry for the non-mathematicians, but we especially interest in practice! Because it is obvious that you will never have to calculate these moving averages yourself, all analysis software and trading platforms offer them.

Moving averages have three main uses: They are used to confirm trends, in some cases to predict reversals (signals), and to identify levels of support or resistance. Let us first focus on moving averages as a trend confirmation tool.

A trend confirmation tool

With a long moving average

This image shows an hourly chart of the EUR / USD, to which was added in blue a moving average at 100 periods (MM100).

The rules of analysis are very simple:

When prices move below their moving average and the moving average is downward, the downward trend is confirmed. 
When prices are above their moving average and the moving average is upward, the upward trend is confirmed. 
When prices pass alternately above and below their moving average, there is no strong trend, and a reversal is to be envisaged. It will therefore be necessary to be particularly vigilant in this case.

With two moving averages (medium and short)

Another way of confirming trends is to study the relative positions of two moving averages of different periods, for example an MM20 (red) and an MM50 (green), as shown in the graph below:

Rules of Interpretation

When the short moving average (here the MM20 in red) is above the long moving average (here the MM50 in green), and their spacing increases, the upward trend is confirmed. 
When the long moving average (MM50 in green) is above the short moving average (MM20 in red) and their spacing increases, there is a downward trend.

A tool to predict reversals and get trading signals

It is useful to have a tool to confirm the trends detected, but it is even better if this tool also makes it possible to make real investment decisions, anticipating the reversals, and thus by providing trading signals. This is what we will see here.

Indeed, the study of the crossings of long and short moving averages can make it possible to detect "trading signals", that is to say to identify the moments when to buy and the moments when to sell.

Rules of Interpretation

When the short moving average (here the MM20 in red) goes above the long moving average (here MM50 in green), this is a buying signal. That is to say, after such a crossing, it is probable that the courts begin a bullish phase.

When the long moving average (here the MM50 in green) goes above the short moving average (here the MM20 in red), this is a sales signal. It will therefore be necessary to position itself for sale after such a cross.

It is clear from practice that these signals are very effective. They certainly do not allow us to position ourselves at the beginning of the trend (that is why the crossovers of moving averages are said to be "delayed" signals), but they remain very relevant.

A small trick to validate the strength of the signal is to look at the crossing angle of the moving averages. Generally, the higher the crossover angle, the more valuable the signal.

A tool to identify levels of support and resistance and goals

Moving averages can also be used as supports and resistors, or rather as trend lines.

Indeed, it is observed that certain moving averages actually play this role accurately, and in this case, their use in trading is similar to the supports and resistances.

On the other hand, long moving averages are sometimes difficult to cross, and can therefore be used to position objectives:

If one is in position and a long moving average is on the way, the courses will have a good chance of encountering a "point of friction" in contact with the MM, which can thus serve as an exit objective

Moving averages: Complete tools with several applications

The moving averages are thus particularly comprehensive tools, which, when properly used, can cover all aspects of a trading operation: trend analysis, position statement and target definition. We urge you to use it!

It is also important to note that effective "settings" of moving averages vary from one period to another and from one currency pair to another and the only effective way to find what works at a given time is The trial and error.

Our Forex University program tells you which moving averages to use when. Learn about this training in 12 hours of video.