Pipsqueaks #22 Part 1: Fun with Moving Averages

Yes indeed it’s 2017 already. I hope everyone had a wonderful New Year’s holiday, I know we sure did. I think for this New Year I’m going to adopt resolutions I can handily keep. I resolve to eat more, I will drink more, I will gain 10 pounds, and I will procrastinate more. Or… Maybe I should just resolve to give up New Year’s resolutions! Why not? Last year when people asked me what I gave up for Lent, my reply of choice was “Lent”.


On to more serious matters. Today I would like to talk about moving averages. For the benefits of those of us who are new to Forex, a moving average (as defined by Investopedia) is a widely used indicator used in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations. A moving average is a trend following or lagging indicator because it is based on past prices. The most common moving averages are the “simple” and “exponential” moving averages. A simple moving average (SMA) is basically an average of price action over a defined number of periods. An exponential moving average (EMA)  is a moving average that gives additional weight to more recent periods. Typically SMA’s and EMA’s are used to identify trend direction and to help determine support and resistance levels. There are lots of ways to use moving averages and were going to explore some of them today.


Let’s look at a chart. Here is a one hour chart for the EUR/USD:

eurusd moving averages trading


Overlaid on the chart are two moving averages – a 70 EMA (green) and a 10 EMA (red). You can see these moving averages cross where price action took a steep drop shown by the large black candle, and price continued down for several hours afterwards. Sort of these indicators telling us? For starters, let’s add one more moving average to this picture.


eurusd moving averages trading chart


The black line in the above chart is a 200 SMA. See what price action is doing in regard to the 200 SMA? Even without the moving averages, you can see a “triple top” form from the three candles whose wicks slightly cross the 200 SMA. This is a bearish reversal pattern typically indicative of a future drop in price action. Now you’ll notice that price action is, starting at the left side of the chart, below the 200 SMA. This is considered a downtrend, even though price is pretty much moving sideways, or consolidating (this is further reinforced on the right side of the chart when the 10 EMA crosses 70 EMA and remained below it). Now we see that after the initial drop, price action is hovering below the 10 EMA (red line), indicating continued strength in the downward direction. Price never crosses into the area between the 10 EMA and the 70 EMA, like it was doing when the market was moving sideways. This becomes the foundation of one of my favorite indicators, a moving average ribbon. The idea behind a ribbon is that strong trends are indicated when price action is on one side the ribbon or the other, and trading is avoided when price action is in the shaded area of the ribbon. See the chart below:


eurusd moving averages trading ribbon


Here I’ve added a ribbon filled indicator (the MA ribbon filled 2 X 14), which is set for 12 EMA and 34 EMA. Notice how it sits nicely between the 10 in the 70 EMA’s. Basically when using ribbons you want to stay out of trades (or exit an existing trade) when price action crosses into the shaded area between the EMA’s. Take a look at the next chart.


eurusd moving averages trading ribbon ema


As time moved on price action wandered into the shaded area of the ribbon (and for that matter between the 10 and 70 EMA’s) and was in consolidation for many hours, signaling the end of a good short position indicated by the cross of the 10 and 70 EMA’s.


That about wraps it up for part one, in part two will look at channels and rainbows. Until then take care and happy trading!


Miss out on last week’s Pipsqueaks article?  CLICK HERE to access!

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