INVESTMENT MANAGEMENT AND CAPITAL MARKETS

Investment Management and Capital Markets

Investment Management and Capital Markets

Part A

Moving averages may seem boring compared to other technical indicators, but there is more than meets the eye when it comes to this simple tool. Not only are moving averages used as directional indicators in the forex market, many funds and speculators have used them in other methods, including key resistance and support levels as well as for spotting turnarounds in the market. As a result, volatility and market fluctuations accompany the placement of moving averages in the currency market much in the same capacity as the Fibonacci retracement. These situations offer plenty of profit and trading opportunities for the FX trader, but picking out these situations takes patience. In this article, we'll show you how to take hold of these opportunities in your trading. (For related reading, see Basics Of Moving Averages and the Moving Averages tutorial.) (Sullivan, arthur; Steven M. Sheffrin 2003, 566-78)

With a broader notion of the market, the simple moving average can be compared to the original market sentiment application first intended for the indicator. At first glance, traders use the indicator to compare current closing price to historical or previous closing prices over a specified number of periods. In theory, the comparison should show the directional bias that would accompany other analyses, either fundamental or technical, in working to place a trade. In Figure 1, we see the application of the 50-day simple moving average (SMA) (or the yellow line) applied to the euro/U.S. dollar currency pair. Following some mild consolidation in the beginning of 2006, bullish buying took over the market and drove prices higher. Here, chartists can confirm the directional bias, as the long-term measure is indicative of the large advance higher. The suggestion is even stronger when showing the added 100-day simple moving average (green line). Not only are moving averages in line with the underlying price action higher, current prices (50-day SMA) are moving above longer term prices (100-day SMA), which are indicative of buying momentum. The reverse would be indicative of selling momentum. (Sullivan, arthur; Steven M. Sheffrin 2003, 566-78)

Support and Resistance

Not only are moving averages used in referring to directional bias, they also are used as support and resistance. The moving average acts as a barrier where prices have already been tested. The more tests there are, the more fortified the support figure becomes, increasing the likelihood of a bounce higher. A break below the support would signal sufficient strength for a move lower. As a result, a flatter moving average will show prices that have stabilized and created an underlying support level (Figure 2) for the underlying price. Larger firms and institutional trading systems also place a lot of emphasis on these levels as trigger points where the market is likely to take notice, making the levels prime targets for volatility and a sudden shift in demand. Knowing this, let's take a look at how a speculator can take advantage of this ...