How to Trade with Moving Averages


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Video Transcript:

Hello, traders. Welcome to the fifth module of the Advanced Technical Analysis course: Trending Indicators. In this lesson, we are going to teach you how to trade with moving averages. How to use single moving averages, specific moving averages, to find areas of support and resistance; how to use moving average crossovers for entries, and how to trail your stocks using moving average so you can get the best of a directional move. So, let’s start with the 200 moving average.

This is one of the most used moving average by traders. This moving average is used as an indicator of overall market direction. This means that overall, if price is trading above the 200 moving average, we are in a bull market; and if price is trading below the 200 moving average, we are in a bear market. This moving average is usually a very strong area of support or resistance that traders should always look at. And, here is an example of a down move with a 200 moving average plot in it. In this chart, we are in a down move and as you can see here, when price hits the 200 moving average, it test it once, twice, three times before actually breaking below.

And, you can always also see that this pattern right here can be that called a flag. So, price is flagging at the 200 moving average. That should give you an extra information to look for a break below the flag and the 200 moving average for a continuation of the down move. And in this case, you can see that we have a great risk to reward entry when we break below these lows and below the 200-period moving average. The reason this moving average is so important is because of its slow reaction to price. When price finally corrects to it and tests it, it will have a strong reaction before defining the next leg of the move. And in this case, the next leg was a down wave.

And as a reminder, the 200 moving average should only be used for longer term entries on higher time frames. And, the reason is because the 200 moving average on the four-hour chart is much, much stronger than a 200 moving average on a one-hour, on a one-minute, two-minute, or even 15-minute chart. So, if you are using the 200 moving average for areas of support or resistance where you can look to trade with a trend or actually trade a reversal on a balance of it, you should go to the higher time frame so the hourly, four-hour. and even daily charts.

Now, the first set up we will be looking at is the 15 and 30-period moving average crossover. This crossover is great for day traders and the reason this is great for day traders is because we are using faster moving average that will react faster to price. So, if we plot a 15-period and a 30-period moving average on the 15-minute chart. For example, we are going to get more entries than plotting them on the four-hour chart. So, this crossover or this system is going to be for the day traders that are looking to get a 50 pip, or 60 pip move, or maybe a 100 pip profit from the move. On a bull set up, we are looking for price to break above the faster moving average, and for the faster moving average to cross above the slower moving average. And on a bear set up, we are looking for price to break below the slower moving average and for the faster moving average to cross below the slower moving average.

Trading moving averages

Here is an example of a price action chart with the 15-period moving average which is the black line and the 30-period moving average which is the red line. Here. we have a crossover. But first of all, we need to identify the break above the faster moving average of price. Here, we broke above but we retested it and we broke to the other side and as you can see, the angle of the faster moving average, is going steeper. And here, we have the crossover and when we get the crossover, we go long. Remember that you have to give your trade some room to breath. The move will not happen immediately. And, this is why you have to put your stock [inaudible 00:04:59] below the previous low in a bull set up and above the previous high in a bear set up. And in this case, you can see that if we enter right here at the crossover, our stocks are never hit and we taking a great trade on an almost one to five risk to reward ratio.

The next crossover we are going to teach you is the Death Cross, the 50 and 200-period moving average crossover. These signals are great for intra-week traders, traders that like longer moves and hold their positions for days. There are fewer signals but they are more solid. And here, we are going to use the higher time frames. For example, on the forward chart, you can plot the 50 and 200 moving average to look for set ups. The set ups are the same when we are using moving average crossovers, the setups are the same. We are looking for price on a full setup, we are looking for price to break above the faster moving average and for the faster moving average to cross above the slower moving average. On a bear set, up we are looking for price to break below the slower moving average, and for the faster moving average to cross below the slower moving average.

Moving average crossover

Now, here is an example of a four-hour chart of the Euro / U.S. dollar with a 50-period moving average which is the red line and a 200-period moving average which is the black line. And, this is the death cross because we already told you that the 200-period moving average on higher time frames is the border between the bull and bear market. So, if we have a cross above the 200-period moving average, we will use the crossover of the 50-period moving average as a confirmation that the overall trend has changed. In this case, we do have a cross above where the price breaks above the 200-period moving average and when we get the crossover here, we go long. In this case, we are going to put our stops below the previous low in a bull set up, and our stops below or above the previous high in a bear set up.

And, you might think that we could have just gotten long here at the break above the 200-period moving average, but the thing about this is that we need confirmation. And in this case when we get the confirmation, we take the position right in this area. In this four-hour chart from the entry until the top of the move, we have a 500 to 600 pip move for a 100 pip risk. So, we do still have a great risk to reward ratio on the higher moves but the thing about this if it’s not your style to hold position for days, you should be looking to trade the faster crossovers on the smaller time frames.

Now, we are going to learn how to trail your stops with the moving average so we can actually manage our positions with it. Once you are in a position, you will use the faster moving average to trail your stops. This is a great thing when you need to get the best of a move. By trailing your stops behind the faster moving average, you will get the best of a strong move either to the upside or to the downside, doesn’t matter or we get stopped out before it reverses completely.

Moving average trailing stops

Now, here is an example where this is the same example of the Death Cross that we used on the previous line, the only difference is that we added the last part of the move where we actually reversed to the downside. Here, we trail our stops to the next test of the slower moving average as support. Now remember, when we are in an uptrend, we are going to trail our stops to the next test of the faster moving average as support. If we are in a down trend, we are going to trail our stops to the next test of the slower moving average as resistance. And in this case, we trail our stocks to the next test of the 50-period moving average as support.

And as you can see here, price tests the 50-period moving average of support before continuing to the off side. Now, we trail stops here and [inaudible 00:09:22] price tested these 50-period moving average again as support and moved higher, we would have trailed our stops to the next test. But, this was not the case broke below and we got stopped out of a winning position before price completely reversed to the downside. Now, this is true with the Death Cross or the faster crossovers. If you continue to trail your stops, you will get the best out of a long trend, and a strong trend, and you will get stopped out before price reverses on you.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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