Think of the moving average as exactly what its name says: the average price. Many years ago, traders viewed a cross of the moving average as a sign the trend has changed direction. But it doesn’t make sense the trend has changed direction simply because price is somewhere above or below its average.
On the other hand, if the average price is rising or falling, then it provides information about the trend’s direction. A rising average price indicates the trend is up; a falling moving average reflects a descending trend.
These two ideas can be used together with two different moving averages and look-back periods. It shows the Euro/ U.S. dollar with a 20-day EMA and a three-day WMA. For example, you could consider the direction of the exponential moving average as the trend. If the EMA is rising, the trend is up. If the EMA is falling, the trend is down.
Next, the three-day WMA can be considered a level of value. If the trend is up as defined by a rising EMA and price is below yesterday’s WMA (we don’t know today’s reading until the close), then price is cheap relative to the upward trend. Consider the area between the rising EMA and the WMA as a buy zone (green area) for intraday and short-term setups.
If the trend is down (the EMA is declining) and current price is above yesterday’s WMA, then price is expensive relative to the downward trend. The area between the falling EMA and the WMA is a sell zone (red area).
Moving averages can be used as a frame of reference to indicate the trend and whether the current price is cheap or expensive relative to the trend. Considering how trends in forex tend to persist, having a tool that keeps you looking for opportunities on the right side of the trend is a very wise first step towards profitability.
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