How to Profit from Moving Averages when Trading Currencies in Foreign Markets

A moving average is a series of snapshots of price taken at intervals, plotted on a price chart as adjacent points that form a line indicating where price has been. The intervals are determined by a chart's time frame. Can you make money with moving averages when trading currencies in the Forex markets? Yes.

Most Forex charting packages will automatically plot moving averages for you, if you select them as one of the many available financial indicators. No specials skills are required on your part, other than choosing the number of time intervals for which the moving averages will be plotted.

Typically, moving averages are applied to the closing price at each of the intervals represented by the chart. 10-period moving averages on a 5-minute chart will plot an average of the last 10 closing prices at 5-minute intervals. In a 15-minute chart, at 15-minute intervals. In a one-hour chart, at one-hour intervals. You get the idea.

Exponential Moving Averages

As you travel back in time through currency pair prices, each price is neither the same nor equally less important than its more recent neighbors. If you think about it, the farther back you travel from the current currency pair price, each price decreases in importance. Decreasing the importance of prices from their adjacent intervals is what exponential moving averages are all about. The importance of each price is decreased exponentially as you travel back through the price intervals, until you reach the final (most distant) interval.

Exponential moving averages are the preferred type of moving averages applied to currency pairs like the EUR/USD and the USD/JPY, to name two. So how do you make money with moving averages?

Crosses

Moving averages are used in pairs: short-period exponential moving averages are plotted alongside long-period exponential moving averages. The 10-period and the 40-period moving averages are often plotted on 5-minute charts. The 89-period and the 144-period moving averages are often assigned to track price action in 15-minute charts or wider. And then there's the most popular of the moving averages: 50-period moving averages matched against 200-period moving averages, best suited for longer time frames like one-hour, four-hour and daily charts.

Pairs of Moving Averages intersect and cross each other on the charts. A "cross" is the most important signal provided by moving averages. Crosses come in two flavors: Golden and Death. To a professional trader, "classic" Golden and Death Crosses occur when 50-period exponent1al moving averages cross 200-period exponential moving averages.

You

You're watching your charts religiously, and suddenly you realize that short-term exponential moving averages are about to cross to the north of the long-term exponential moving averages. Wow! Prices appear certain to continue their upward climb! Such a cross, pointing north, is called a Golden Cross. Time to buy when you see a Golden Cross taking shape? Maybe.

Maybe you see short-term exponential moving averages crossing south of long-term exponential moving averages, with prices starting to drop. This kind of cross is called a Death Cross. Are you going to go short and sell the next time you spot a Death Cross? Maybe.

Smart traders easily recognize Golden Crosses and Death Crosses early in the game as they start taking shape. To you, this means that by the time a cross does take place, price exhaustion and reversal may be in motion, and it may be too late to enter the market. Behind each cross that you consider as a trade entry point, you need some "ooomph"-- something that will convince other traders that prices should by all means continue in the direction of the cross.

To profit from moving averages, then, you need to look at a minimum 3 time frames for the currency pair that you are considering: the 5-minute chart, the 15-minute chart and the one-hour chart. Professional traders seldom if ever trade based on signals from only one financial indicator, so let's be sure to include MACD and Stochastics as additional indicators on each of our charts and look to these two additional indicators for our ooomph.

High Probability

In a high-probability scenario, price is trending in the same direction in all 3 time frames, the same direction as the cross, and MACD as well is pointing in the same direction as the trend in all 3 time frames. In an uptrend, Stochastics is showing an oversold condition, near its "20" signal line, and starting to turn in the direction of the trend (UP). In a downtrend, Stochastics is showing itself as oversold near its "80" signal line, and starting to turn in the direction trend (DOWN).

There remains but one thing before you start banking your profit pips: observation. Observe how our high probability scenario unfolds more than a few times. Practice paper trading with the purpose of fine-tuning you trade-entry timing. In the Forex currency markets, timing is everything!

From paper trading, once you are confident about your timing, escalate to a demo trading account, where you practice with "pretend" money. The time to go live is when you are winning 70% of your trades-- while actually showing a profit.

In Conclusion

In summary, moving averages can indeed yield profit when trading currencies in the Forex markets. However, before you can take money to the bank, you must look for trade entry confirmation from at least two other financial indicators, MACD and Stochastics being worthwhile choices for your consideration. And you must practice, practice, practice! Practice on paper, and practice demo trading. Only when you are showing steady profits in your demo account should you begin to think about trading with your own hard-earned cash!