Averages serve one key purpose, to smooth out price action. In so doing, it should give a trader a better feel for how to trade certain markets. We often talk about the major moving averages of 50, 100 and 200. However, smaller moving averages serve a purpose as well. Many traders use moving averages corresponding to Fibonacci numbers (3,5,8,13,21,34 etc….).
On the chart below we not only identify the majors but also the 3, 8, and 13 moving average. The 50 MA has not been taken out in a while so when price and the 50 MA converge that cross will be a point to watch. If you have been short the EUR you could use the 13 SMA as near term Resistance. If you wait for your faster moving 3 SMA to cross your 13 SMA, instead of price itself as a signal to exit, you would not have exited back on May 23rd (see blue arrow). Utilizing faster SMAs also indicates when a trend is present versus near term ranging and or consolidation. Right now you can see the faster SMA’s are starting to trade horizontally and in close proximity to one another, therefore momentum has slowed.
We use the same MA’s for the GBPUSD chart below. Notice on the chart the 3 different periods and the corresponding alignment on the faster MA’s. The first period is consolidation and you can see the horizontal movement of price as well as the converging moving averages. A potential short opens up with the 13 MA greater than the 8MA, which is greater than the 3 MA. When prices falls, the faster MA should be under the slower MA’s as it tracks closer to price. With the completion of the last candle the faster SMA’s have signaled a potential new Long. However, always keep in mind the major MA’s as taking a long here would still be trading against the prevailing trend.
In the 2 examples above we have seen the implications of a rising and falling moving averages. What is the appropriate course of action when MA’s are not in numerical alignment? The simple answer could be, just do not trade. Firstly, always taken note of the major MA’s. The CAD has been sitting on the 200 MA for the last 5 sessions. The 200 MA is a pivotal point and the fact that CAD has not been able to bounce directionally means there is no clear point of entry. The faster MA’s confirm this as the 8 sits above the 3 and the 3 above the 13, indicative of a point of consolidation. On the one hand you have a slower (8) MA above a faster (3) MA, but you also have a faster(3) MA above a slower (13) MA.
Written by bforex.com