Moving Averages – Find Support and Resistance Areas
Moving averages are extremely popular among traders as they represent one of the most used trend indicators available. The cause for their popularity comes from the fact that they are simple to use and interpret and yet the signals generated are strong enough to allow traders to profit from market swings. Traders use moving averages for multiple reasons but the most important use of this indicator is to help find support and resistance area, or areas where a trader might want to add another trade in a trending environment. Riding a trend doesn’t only mean to stay in the trend for the whole period but also to add to the initial position when market retraces. This is why moving averages are for. Trading with moving averages is very simple but yet the implications so powerful that traders look very careful when the price is meeting a higher average for the first time as most likely it is going to be rejected from it. Because of this, there are a variety of trading strategies developed around moving averages and how the price is reacting when it is reaching them.
RECOMMENDED FOREX BROKERS
|Broker||Min Deposit||Regulation||Bonus||Read More||Visit Site|
|XTrade||$100||CySEC||60%||Read Review||Visit Broker|
|XM||$5||CySec||100%||Read Review||Visit Broker|
|HYCM||$50||FSA||$5000||Read Review||Visit Broker|
Moving Averages Generalities
Moving averages are of multiple types but the ones to be used are the Simple Moving Averages (SMA) or the Exponential Moving Averages (EMA). Out of the two, the SMA is a fixed one, in the sense that by the time a value it is plotted on a chart it is going to stay there forever, while the EMA adapts to future price levels. From this point of view, the SMA is more reliable. As a rule of thumb for any indicator, no matter if it is a trending one or an oscillator, the bigger the time frame it is attached to, the more important its interpretation is. For example, it is one thing the price is meeting a moving average on the hourly chart, and a totally different thing if the same thing is happening on a monthly or weekly chart. The support/resistance levels on the bigger time frames are by far more important than the ones on the hourly. Moving averages are offered by any trading platform and we’ll use the MetaTrader 4 to show where the indicator is to be found and how to apply it on a chart. Simply open the MetaTrader 4 trading platform and under the Insert/Indicators/Trend tab, the Moving Average indicator can be found.
By clicking on it, a pop-up window appears and in that window, we have the possibility to customize our indicator. More exactly, we can choose the period it is going to take into consideration as well as other things like simple or exponential or another type of moving average we want, the color or it, appearance, etc. The bigger the period a moving average is taken into consideration, the more difficult for the price to break.
Trading with Moving Averages
As the title of this article suggests, the main idea of using moving averages is to find out support and resistance levels price may meet. Once such areas are found, a new trade in the general direction of the trade can be taken.
However, there is another way to use this averages, and this is to split the market into a bullish and a bearish one. Based on the time frames the moving averages are applied, the implications for future price action are very important from both a short to medium term perspective as well as from a long-term one.
Golden and Death Crosses
The most popular and simplistic way to use moving averages is to divide the market into a bullish or a bearish one based on a cross. Even today, financial newspapers are referring to this crosses as being really important and defining for a market. In order to look for a golden or a death cross, a daily time frame needs to be open on the financial product one is interested in trading. In our case, let’s use the daily chart on the EUR/USD pair. The next thing to do is to apply on the chart two different moving averages: one that takes into account 100 as a period (MA100) and one that considers 50 as a period (MA50). This means that MA100 is plotting a value based on the values of the last one hundred days, while the MA50 one is taking into account only the last fifty days.
The overall idea to interpret a market is quite simple: when the MA50 is moving above the MA100, or it is making a cross, this cross is called a golden cross. It means that from that moment on the overall market turned bullish and buyers should dominate that market. The opposite is true as well: when the MA50 is crossing the MA100 to the downside, the cross that formed is called a death cross and signals a bearish environment in the period ahead. The EUR/USD chart below shows both golden and death crosses as the MA50 (the blue line) is crossing above or below the MA100 (the black one).
Finding Support and Resistance Levels in Trending Markets
Another way to use moving averages is to apply multiple ones on a chart in order to spot trend reversals or to add a position in a trend that already started. In doing that, the moving averages to be used are the MA20, MA50, MA100, and MA200. Below is the four-hour chart on the EURUSD pair with all four moving averages plotted. The MA50 and MA100 have the same color as on the previous example, while MA200 and MA20 are represented in brown and magenta respectively.
The idea behind this strategy is to wait until all those four moving averages are aligning in the so-called perfect order (20, 50, 100 and 200) and then trade in the direction of the overall trend when price is moving into the 50, 100 or the 200 MA, while the MA20 is not crossing above/below the MA50. The moment that this is happening, the support or resistance levels are not supposed to be used anymore. As mentioned at the start of this article, moving averages are a simple, yet very effective way to look at markets. Traders should use them with confidence as the underlying price is always more important than the fundamental news that causes a spike or a dip to happen.
Other educational materials
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- Bollinger Bands – Profit from One of the Best Trend Indicators
- Trading with the Cloud – Use Ichimoku Cloud to Spot Reversals
- Trading Sessions and Their Importance
- Fundamental Analysis – What It Is and How to Use It
- Technical Analysis – What to Consider
Recommended further readings
- Study Guide for Technical Analysis Explained. Pring, Martin J. McGraw-Hill, 2002.
- “Technical analysis in the foreign exchange market: a layman’s guide.” Neely, Christopher J. Review 79 (1997).