Most traders and investors still focus on the most traditional forms of investments such as stocks, futures, options and bonds despite the opportunities that the Forex market offers. The Forex market is generally identified as the most liquid and constantly active market in the world. It is only in recent years that individuals are coming to realize the real opportunities that present themselves in the Forex market.
Finding Trends: Use of Moving Averages
That being said, trading in the Forex market must be carried out very carefully and with a sound strategy in mind. Traders are advised to firstly identify whether they would prefer to use short term strategies or long term strategies. The manner in which they go about trading will be entirely dependent on this decision.
Trends in the Forex market
While it is true that long term strategies typically have a lower degree of risk associated with them than short term ones, Forex traders still constantly engage in short term trades owing to the fact that they may be more profitable. One of the most common strategies used in Forex trading is that of trading in the direction of the trend. Trading against the trend is extremely risky in comparison. As such, it becomes extremely important to a Forex trader to accurately identify a trend in the Forex market before following it up with a trade. There are a number of ways to calculate these trends. One of the most popular methods used to do this is that of moving averages.
A currency in the Forex market is subject to a number of fluctuations over the course of a time period. These fluctuations are impossible to predict and typically provide little value to a trader. The moving average is used to factor out these fluctuations so that a trader can gain more insight into the direction in which a currency is heading. Objectively identifying a trend is the first step towards setting markers for entry and exit.
Before moving averages can be calculated, it is important to identify a particular time period in which they are to be calculated. The time period that a trader will use will be dependent on what strategy is going to be employed. A major trend in a currency is usually identified as bullish, bearish or neutral. While none of these methods will always hold true, they are tried and tested methods that have proven to be effective more often than not.
A moving average will immediately enable a trader to visualize the major trend that a currency is experiencing, thereby allowing him/her to develop strategies that move along the trend. While moving averages can be an extremely effective technique, it must be said that there is always a likelihood that a currency may display whipsaw signals. Whipsaw signals are generally defined as fluctuations that cannot be predicted or anticipated. These fluctuations make it very difficult for traders to set markers for entry and exit.
How to calculate moving averages
A moving average is generally calculated by splitting a Forex currency chart into individual periods and calculating the average price in each period. These prices are then collated and analyzed to determine what trend a currency is currently experiencing. If these averages seem to be rising, the currency is said to be experiencing an upward major trend. Conversely, if these averages are decreasing, the currency is experiencing a downward trend. In some cases, these averages may display minimal fluctuation thereby exhibiting no real trend. A currency is said to exhibiting a neutral trend in such cases.
Most traders use moving averages associated with different time periods. The shorter the time period in which an average price is calculated, the lesser insight it will provide to a trader. It is this reason that traders generally incorporate three or more moving averages with differing time periods into their strategies. When all three moving averages display an upward or a downward trend, it is generally a good indication that the trend is real and accurate.
While moving averages have continued to be one of the most effective tools in analyzing trends in the Forex market, it is also important to understand that they must be used in conjunction with other indicators. Moreover, moving averages themselves may act as triggers for price action so using caution is always recommended.