Moving averages can be used to assist you determine the trend.
The simplest method is to just draw a single moving average on the chart.
When price movement tends to stay above the moving average, it indicates that the market is in a UPTREND.
If price movement remains below the moving average, it signals that the market is in a DOWNTREND.
The problem with this is that it’s too simplistic.
Assume the USD/JPY has been in a downtrend, but a news story causes it to leap higher.
You can see that the price is currently ABOVE the moving average. You think to yourself:
“Hmmm… This couple appears to be about to change course. “It’s time to buy this suckerrrr!”
So you do just that. You purchase a billion units because you believe the USD/JPY will rise.
Bammm! You’ve been duped!
As it turns out, traders simply reacted to the news, but the pattern remained and the price continued to fall!
Some traders, and we recommend you do the same, plot many moving averages on their charts rather than just one. Depending on the order of the moving averages, this offers them a clearer indicator of whether the pair is trending up or down.
Allow us to clarify.
In an uptrend, the “faster” moving average should be higher than the “slower” moving average, and vice versa in a downtrend.
Assume we have two MAs: a 10-period MA and a 20-period MA. On your graph, it would appear like this:
This is a daily chart of the USD/JPY.
The 10 SMA has been above the 20 SMA throughout the rise.
As you can see, moving averages can be used to determine if a pair is trending up or down.
Combining this with your understanding of trend lines can help you decide whether to go long or short on a currency pair. You can also experiment with more than two moving averages on your chart.
You can tell whether the pair is in an uptrend or a decline by the sequence of the lines (faster MA over slower MA in an uptrend, slower MA over faster MA in a downtrend).
Next Lesson: How to Use Moving Average Crossovers to Enter Trades
