The moving average indicator as we know it is one of the most widely used technical indicators in Forex trading. Primarily used for determining Forex market trends, the moving average indicator is also used in a number of other technical analysis applications.
The popularity of this MT4 indicator comes due to its simplicity. Because the mathematical calculations behind the moving average are so easy to understand, traders at all levels find it a very comfortable indicator to start Forex trading with.
When one talks about moving averages, perhaps one of the first things that come to mind is the moving average crossover strategy.
Yet, besides this and a few other applications of the moving averages in other strategies, this versatile indicator can be used in many other ways.
In this article, we will outline a few ways you could use the moving average.
An important thing to note is that the moving average is merely a reflection of the average price.
As a result, some FX traders might find that the moving average is lagging. This is indeed true. Moving averages show you the average price of the instrument over a period of time. Thus, they tend to reflect the trends in the past, rather than predict Forex market trends. Understanding this is crucial when it comes to getting one’s expectations right with this MT4 indicator.
Dynamic Support and Resistance Levels
The moving average indicator is a versatile indicator in identifying dynamic support and resistance levels. Of course, this is a bit subjective.
Typically, the 200 and 50-day moving averages are commonly used on the daily chart time frame. Because these indicators are so widely used, they tend to act as dynamic support and resistance levels.
For example, the chart above shows an instrument on the daily timeframe. You can see how the indicator tends to act as support and resistance for the prices.
You could, of course, make use of a moving average of any other lookback period or on any timeframe of your choosing. However, the most commonly used moving averages are better at acting as dynamic support and resistance levels.
The Moving Average Slope
The slope of the moving average reflects the intensity or the momentum in the instrument. Thus, when you find that the moving average is sloping at a steep angle, you can deduce that the price is declining or rising rapidly.
This can give FX traders information such as the momentum and can even lead you to identify the fundamental factors behind such a move. Forex traders tend to mistake the slope of the moving average as something that is currently happening.
However, bear in mind that given the lagging nature of this indicator, it reflects only the past price action. Still, the information one can get out of this can be used in different ways to find an edge in the Forex market.
Reversion to the Mean
Mean reversion in finance is a tendency of an instrument’s value that changes over time.
In the long term, the price tends to gravitate to its long-term average value. The concept of mean reversion is not predictive in nature. Furthermore, mean reversion can behave differently depending on the asset class as well.
Some FX traders tend to disregard mean reversion because it means that the forex markets do not follow a random walk, thus leading to an inefficient market. Still, depending on how you look at it, prices tend to correct (after extreme moves) to the long-term mean.
A 200-day moving average is a great example of mean reversion. Prices that tend to move significantly away from the long-term mean tend to revert to the mean price over time.
While this isn’t the basis for building a Forex trading strategy, one could still apply the concepts in different ways. For example, FX traders could avoid buying near extreme highs or lows.
In conclusion, the moving average indicator finds its uses not just in Forex trading strategies but also helps in building advanced math based trading systems as well.