Interpreting Moving Average Signals

Overview

Moving averages provide input into the overall direction and momentum of a currency pair.
Because moving averages are easy to apply, they are often used in conjunction with other indicators to confirm a market direction.



SINGLE MOVING AVERAGE SELL SIGNAL

A sell signal is indicated when the spot rate crosses under the moving average.
This suggests that the market price is losing momentum and is under-performing when compared to the moving average.












Single Moving Average and Spot Rate Sell Signal
In the chart above, note where the spot rate crosses under the moving average – this is a classic sell signal.
The fact that the "double-top" chart pattern occurs at roughly the same point, reinforces the level as a likely sell opportunity.
This is indeed the case as the spot rate suffers a pronounced decline shortly after the initial crossing.





SINGLE MOVING AVERAGE BUY SIGNAL

When the spot rate crosses over the moving average, this is an indication that the spot rate is trending upwards as it is increasing at a faster rate than the moving average.
For this reason, this is typically seen as a potential buy opportunity.
Again, you are advised to confirm the analysis – in this case, the "reverse head and shoulders" pattern (as seen in the chart below) is a common rate reversal signal:












Single Moving Average and Spot Rate Buy Signal
When using spot rate and moving average cross over trading signals, it is important to keep two points in mind.




Depending on market volatility, cross overs can be extremely unreliable so it is advisable to seek additional confirmation before acting. In the buy and sell examples we examined here, the formation of a double-top and a reverse head-and-shoulders pattern helped confirm the market direction.


The number of reporting periods included in the moving average calculation can have a tremendous effect on the moving average. The basic rule to remember is that the fewer the number of reporting periods, the closer the average stays with the spot rate.



SIGNALS PRODUCED BY MULTIPLE MOVING AVERAGE CROSSOVERS





Traders often place several moving averages on the same price chart. Typically, one of the moving averages will be designated the faster moving average consisting of fewer data points, and one will be a slower mover average.
By definition, the faster moving average will be more volatile than the slower moving average. This is demonstrated in the following 1-day price chart that has been modified to include two moving averages:




The fast moving average is calculated from just seven days of data.


The slow moving average is based on a full thirty days of data:












Slow and Fast Moving Averages Showing Crossover Signals





The moving average with the fewer data points (the fast moving average) responds more quickly to a change in the spot rate.
If the fast moving average crosses above the slower moving average, it is considered abuy signal.
When the faster moving average crosses below the slower moving average, it is considered a sell signal.












Slow and Fast Moving Averages Showing with Very Slow Moving Average

Source : oanda.com