Trend Indicators Explained: Moving Averages And Bollinger Bands
Over the past few years, technical analysis has expanded significantly with improvements in technology. With a few clicks of the mouse, traders have the luxury of viewing real time charts and performing detailed analysis on their computer screens. Mtradee.com offers some of the most valuable and popular technical indicators used in forex trading software.
Trend and Oscillator Indicators Explained
The indicators can be divided into two main groups: Trend Indicators and Oscillator Indicators.
- Trend indicators aim to predict the general market direction using various tools like price patterns, support and resistance levels, trendlines, and moving averages.
- Oscillators used in conjunction with trend indicators can greatly benefit traders by highlighting short-term market extremes, commonly referred to as overbought and oversold conditions.
We will discuss the application of the trend indicators in detail.
Moving Averages are considered by many technical analysts to be the most important trend indicators. The Moving Average is a lagging indicator that shows the average value of a currency’s price progressing over a certain time period. There are three different kinds of moving averages:
Moving averages can be calculated on any data series including a currency’s open, high, low, close, or other.
The Simple moving average is basically the arithmetic mean of the most recent prices for a particular time period. For example, adding the five most recent day’s prices and dividing that sum by five will obtain the 5-day moving average. The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Exponential and weighted averages apply more weight to recent prices.
Keep in mind there are no hard and fast rules, but many traders make use of one or more moving averages at the same time. We recommend using the 4-9-15 days for the very short term, and 5-20-60 and 7-21-90 for medium or the long term. As expected, the sort of interval you choose should depend on the time frame for your trading strategy.
Methods Used For Incorporating Moving Averages
There are two popular methods that analysts use for incorporating moving averages:
- Double Crossover Method
- Triple Crossover Method
The Double Crossover Method
The Double Crossover Method uses two moving averages. A buy signal occurs when the faster of the two averages crosses the slower one and moves upwards. When the faster average crosses the slower one and moves downward, it is treated as a sell signal. A faster average represents a shorter time interval while a slower average indicates a longer-time interval.
The Triple Crossover Method
The Triple Crossover Method involves three moving averages. This is a two step method and it generates a warning signal that precedes the trade signal. The intersection of the faster averages generates a warning signal and the intersection of the slower averages following the initial intersection of the faster ones gives traders the signal to trade.
The 4-day moving average crosses the 9-day average and subsequently intersects the 18-day average and then continues upwards. This is a warning signal to buy. The actual signal to buy is generated when the two slower averages, the 9-day and 18-day averages, cross each other.
Moving averages are easy to use and they notify traders of several entry and exit opportunities in the market. However, it is important to remember that these methods are not always on target and may sometimes generate false breaks.
This is another important trend indicator. Bollinger Bands surround the movements of the currency by forming two bands situated exactly at two Standard Deviations from the moving average. Many chartists will agree that one standard deviation is usually 20 days. The upper band is two deviations above the moving average and the lower band is two deviations below it.
Bollinger Bands are very useful in serving as price targets. If the price rebounds off the lower band and moves above the 20-day average, the upper band becomes the upper price target. A crossing below the 20-day average would make the lower band the downside target.
After the currency crosses below the 20-day moving average, the lower band serves as the price target on the downside. Each of the green circles around the lower bands reflects a market bottom and could have served as a good buying opportunity.
Oscillators combined with trend indicators present useful insights and can aid traders in making better trading decisions.