T
he best way you can use those Moving Averages is to make them show you the trend.
If you plot a single moving average on the chart, it will show you whether the price is in uptrend or downtrend, depending on the price action.
If it stays above the MA, you have an UPTREND.
If it stays below the MA, you have a DOWNTREND.
Let’s see if this simple way is the best possible way to determine the trend, though.
Take for example the currency pair USD/JPY.
You can notice that it has been in a downtrend until the moment when a news report comes out and made the price go higher.
When you see that the price is now ABOVE the moving average, you will think that this is an indication of the beginning of a new trend.
If you go long and buy many units at this moment, you should know that you will be losing money.
You thought that USD/JPY is going to go up, but you get faked out.
What happened is that traders reacted to the news and the demand became bigger, but it was only for a while and then the trend continued, causing the price to go lower!
That’s why it is good to plot a couple of moving averages on your charts instead of just ONE.
If we take an uptrend as an example, you need your “faster” moving average to be above the “slower” moving average.
In a downtrend, you have to apply exactly the opposite.
Let’s overlay two MAs: the 10-period MA and the 20-period MA on a daily chart of USD/JPY.
As you know the shorter the period, the faster it will be its response to the price action.
So the faster-moving average(10 SMA) is above the slower moving average(20SMA).
When your lines are in order (faster MA over slower MA in an uptrend, slower MA over faster MA in a downtrend), you will be able to tell whether the pair is trending up or down.
You can plot as many MAs as you want on your chart, as long as you combine your knowledge on trend lines, you will know if you need to go long or short a currency pair.
