Learn this powerful Fibonacci Retracement method FREE that pulls 500+ pips per trade. Get this 1 Minute Forex Trading System FREE that makes money instantly anytime you want even if you are a beginner at forex trading. Download these 3 Swing Trading Systems FREE. Moving averages are one of the most simplest and widely used trading indicators. Why don’t Moving Averages (MAs) work as a forex trading tool? Because they are lagging indicators. Let’s discuss moving averages and their limitations. First what is a moving average? MA is simply the average of the past closing prices over a certain period. It can be a 10 day MA, 50 day MA, 100 Day MA or 200 Day MA.
Whatever, there are three types of moving averages. Simple Moving Average (SMA), Exponential Moving Average (EMA) and Weighted Moving Average (WMA). SMA is the simple average of the past closing prices. It places equal weight on the past prices. On the other hand the EMA is the exponential average of the past closing prices over a certain period. It gives more weight to the recent prices as compared to the old prices. This makes EMA highly responsive to the changes to recent past prices as compared to the distant past prices. WMA gives weight to different prices.
What you must have observed is the EMA is the best MA as it gives more importance to the recent changes in the prices as compared to the changes that took place weeks before. Many trading systems use EMAs. Now, another thing that you must have observed is that all these MAs are the average of past prices. What does this means? It is lagging. It trails the price action and always lags behind it.
So, when you use MAs, they lag behind the price action and whatever trading signals that you get are always late. This is very important to understand. Another limitation with MAs is that they have a tendency to whipsaw a lot in a choppy market. They work well when the market is trending nicely but whipsaw a lot under a market moving sideways. The shorter the time period used in an MA, the more whipsaw it will have. Shorter period MAs move fast while longer period MAs move slowly.
What this means is that using MAs in a choppy market can give you a lot of false trading signals. In order to avoid false trading signals with MAs, a combination of two or more moving averages are used. It is best to use two MAs or three MAs in combination. This combination filters out a lot of false trading signals. Combining these MAs with candlestick patterns can be a powerful combination. Keep these limitations of MAs in mind when you trade. Good Luck!