Since I started trading, I have tested many indicators along my journey, with nearly all failing to meet my trading personality or pass my backtests. Indicators could work for you, with many traders swearing by them and providing excellent educational resources. They come in more useful when using a system-based trading system. I especially like the channel nononsenseforex for its superb coverage of different indicators.
The only indicator I use now is a Simple Moving Average (SMA) and volume whilst reading price action.
The Simple Moving Average (SMA) and the Exponential Moving Average (EMA) are two types of Moving Averages traders mainly use.
The Difference
A Simple Moving Average is the closing price of a financial instrument within a set period and then divided by the number of total periods. For example, a 20 Day SMA calculates the closing prices over the last 20 days and draws a line on the chart.
An Exponential Moving Average, however, puts more weight on the data, making the calculation more complex.
- EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier)
Traders use the EMA to identify price changes earlier but, in my experience, this can flag up false signals more frequently too, making me favour the SMA. As with all my trading, simplicity is vital. I suspect a trader used the SMA and then found a way to overcomplicate things and marketed his calculations with the promise of riches.
The Moving Averages help you identify the chart trend by cutting out the noise of short-term price moves. As a trend trader, I only want to buy with rising moving averages and sell when falling. I mainly look at the 50 SMA, and I only like to go long when above the Moving Average and sell when below, identifying the position over multiple time frames.
Support and Resistance
A moving average can also act as support or resistance. In an uptrend, a moving average may act as a support level because the average acts like a floor. In a downtrend, a moving average may act as resistance; the price hits the level like a ceiling and then drops again.
Some traders favour the 100 SMA to provide the strongest S/R.
Moving average crossovers
Another popular way of using the moving average indicator is a crossover technique by applying two or more moving averages to a chart with different data periods. A trader uses a slower-moving average with fewer periods and a longer MA with more periods. When the shorter period crosses a longer period, this can present a bullish trading opportunity, and when it crosses below, this could be a signal to sell.
I am not a fan of the method and do not use this in my trading.
In conclusion
Generally, a market can be considered bullish when trading is above a rising moving average and bearish when trading below a falling moving average.
I like cutting out all the noise and identifying a trending market using the SMA, but this is a small piece of the information, and I do not enter a position using just a moving average.
Trading is about trying new things and experimenting. Try an SMA or an EMA on different time frames with varying sets of parameters and record your findings. As the most common indicator, most trading platforms provide an SMA and EMA on your charts.
