Using moving averages as a basis for a trading strategy is great for newbies because they are indicators that are simpler to understand — it is simply an average of the price within a given period. And even when using exponential moving averages, all you have to know about the indicator is that it is an average that puts more weight on recent prices.
Since the basis of moving average strategies is an indicator that is simple and easy to understand, these strategies are perfect for newbies as their simplicity reduces the risks of making mistakes. Furthermore, since even someone who is new to trading can understand the underlying principle behind the strategy, pulling the trigger once opportunities arise will be easier for new traders due to the increased confidence that their simplicity evokes. The following are simple moving average strategies that almost any newbie forex trader can use successfully.
Going with the trend strategy
Generally, when a simple moving average increases, it is usually an indication of an upwards trend. Therefore, you can use the simple moving average to tell whether the price will trend upwards, and even the strength of that trend. In such a case, you will buy as soon as there is a price breakout and the moving average starts trending upwards. You will then sell when the moving average indicator starts line starts to flatten out as this is typically an indication of a likely change in tide.
However, this does not mean that you can only make money when the price is trending upwards. You can always take a short position in cases where the moving average indicates the likelihood of a downtrend. In such a case, you will then exit the position as soon as the tide starts to change.
The gap strategy
The idea behind this strategy is that when there is an extreme gap, it typically fills up. And while this is not a 100% bet, it is a generally safer bet given that this is something that happens at least 50% of the time. Therefore, what you do is that you use the simple moving average to gauge where the trend starts, and then you wait until it gets to its highest point. And once it starts to slowly go downwards, you simply enter a short position. With time, the gap will start to fill up as the price goes back down towards its original position. And as this happens, you will be making a profit.
The crossover strategy
With the crossover strategy, you will first need to have moving averages that have two different time spans. The 200 and the 50 period simple moving averages are a common choice among forex traders. However, it is important to note that you don’t have to stick to these two moving averages. In fact, it is recommended that you tailor the period to your strategy since using a 200-period moving average can prove to be ineffective for a day trader.
After you have settled on two related moving averages with different time spans — you should always choose a long term moving average and a short term one — you should then proceed to observe your chart. Every time the two moving averages cross over each other, then that is a clear indication of a trading opportunity.
Generally, there will be a buy opportunity when the short-term moving average crosses above the long-term moving average. On the other hand, when the trend reverses and the short term moving average crosses below the long term moving average, then you should think about exiting your position. You can also use these crossover points to determine the ideal points to place your stop loss orders.
These are the most commonly used simple moving average strategies. When using them, it is important to note that the moving average is a lagging indicator, and as such, stays a step or two behind the actual market. As a result, relying on a strategy like the crossover strategy can compound the problem. Keeping this in mind will go a long way towards helping you to manage the risks posed by these strategies. But other than this, it is a solid indicator that is used not only to determine whether to enter or exit trades, but also identify support and resistance levels.