One popular method technical analysis used by traders is to trade the moving average cross over. They often use this method as an indication of when they should buy or sell currencies.
The line that indicates a trend and which is plotted on a chart is called a moving average. In order to calculate a moving average, you must add the closing price of a pair of currencies over a certain number of time periods. If you were going to make this calculation based upon the hourly closing price and the time periods were 150 then your equation would be (150xhourly closing price)/200. The most accepted periods for these calculations are one hour, four hours, eight hours, and on a daily basis, but the equation can be formed with any period of time. There are a variety of moving averages. A simple moving average is determined by the above equation. An exponential moving average is influenced more by the most up to date closing prices. A linear moving average is just like an exponential, but the influence by the most current closing prices is even greater.
The moving average is used by traders to indicate the beginning of a trend. That trend can be either bullish or bearish. The below chart shows what either trend might appear as.
In order to see where the bullish and bearish trends begin and end, as well as to indicate when you should trade with a cross over, you add the simple moving lines to this one hour chart. The slow line (white) is measured over twenty time periods, and is going to be relatively flat because it uses twenty past closing prices. The second line (yellow) only uses five historical closing prices and this causes the line to follow changes in the closing price more closely. This line is known as the fast line and is visible on the chart below.
How do you trade the moving average cross over?
Foreign Exchange traders favor a trading strategy that calls for the moving average cross over. This is because it is a lagging indicator. Lagging indicators result when the sell or buy indicator is more precise because of a lack of market noise. On the below chart, you’ll notice that the yellow, fast line, crosses over the white, slow line. In this chart, the price of the euro was decreasing before the crossover indicated that the trader should sell. If the trader sold before the crossover took place, it could have resulted in losing money on the trade. The line continues to fall before it begins to trend sideways. Then, the fast line (yellow) crosses the slow line which indicates that the trader should buy. A trader who decided to make a trade when the moving average indicated that they should buy would have profited from the trade, but if the trader waited and kept the trade open for several days, they would have made a larger profit.