Moving averages and trend trading

In this lesson, we look at another technical analysis tool that helps traders to identify market trends: moving averages. The lesson includes a step-by-step exercise for you to practise setting MAs and identifying trends.

What is a moving average?

The simplest answer is that it's an average of price data. A more detailed explanation is that a moving average (MA) is a technical indicator that smooths out price action by calculating the average closing price over a specified period. This helps traders filter out market noise and identify the underlying trend direction.

Two of the most commonly used moving averages are the simple moving average (SMA) and the exponential moving average (EMA). Both help identify trends, but EMAs place greater emphasis on recent price data, making them more responsive to current market moves.

Moving averages are versatile tools that work well across different markets, whether you're trading forex or stocks. They're especially helpful for newer traders learning to spot trends but are often used by seasoned traders as part of their broader strategy.

How do moving averages indicate trend direction?

The interaction between price and MAs can offer valuable insight into trend direction. When the price consistently stays above a moving average, it often signals an uptrend.

If it remains below, it usually points to a downtrend.

The angle of the moving average also matters — an upward-sloping MA typically reflects bullish momentum.

Traders often combine moving averages with other technical indicators, like momentum tools or signal-based systems, to strengthen trend confirmation.

Some strategies also use two or more MAs to analyse price action across different timeframes, helping to spot longer- or shorter-term trends.

Important crossover points

The golden cross is a bullish chart pattern that occurs when a shorter-term moving average (usually the 50-day) crosses above a longer-term moving average (such as the 200-day).

This crossover suggests that upward momentum is building, and it's often seen as a strong signal that a longer-term uptrend may be starting. Many traders and analysts view it as a key indicator of potential buying opportunities, especially when confirmed by rising volume or other supporting indicators.

The morbid-sounding death cross is simply the counterpart to the golden cross: a bearish chart pattern that happens when a shorter-term moving average (also typically the 50-day) crosses below a longer-term moving average (such as the 200-day).

This crossover signals that downward momentum may be taking hold and is often viewed as a warning of a potential long-term downtrend. Like the golden cross, it carries more weight when confirmed by high trading volume or other bearish indicators.

Stacking moving averages

Stacking moving averages involves using multiple MAs — typically the 20-day, 50-day, and 200-day — to get a more complete picture of market trends.

In a strong uptrend, the MAs will usually align in order from shortest to longest: the 20-day on top, the 50-day in the middle, and the 200-day at the bottom. This formation is often called a bullish stack.

In a strong downtrend, the order reverses: the 200-day sits at the top, followed by the 50-day, with the 20-day at the bottom, combining to form a bearish stack.

The distance between the MAs also matters. When they’re widely spaced, it suggests a strong trend. If they start to bunch together or cross over, it could mean the trend is weakening or about to reverse.

This stacking method can be applied across markets, from forex and stocks to indices and commodities.

Common mistakes with MAs

While moving averages are powerful tools, they're not without limitations (as with any single technical analysis tool). Here are some common mistakes traders should watch out for:

Relying on MAs in isolation
Moving averages are best used as part of a broader strategy. Relying on them alone – without considering price action, market structure, or other indicators – can lead to missed signals or poor trading decisions. They work well for confirming trends but are not designed to predict sudden reversals or unexpected volatility.

Using too many moving averages
It can be tempting to layer on more and more MAs with different timeframes, but this can create more confusion than clarity. A cluttered chart makes it harder to spot actionable signals. For most traders, two or three key MAs — such as the 20-day, 50-day, and 200-day — are sufficient to capture short-, medium-, and long-term trends.

Forgetting that MAs are lagging indicators
By nature, moving averages are based on past data, which means they respond to price changes after they've occurred. This makes them great for confirming a trend but slower at reacting to sudden market shifts. Entering trades purely on MA crossovers can mean entering a trade too late if you don't factor in other signals.

Ignoring market context and risk management
An MA crossover in a choppy, sideways market might give false signals. It's important to always consider the broader market environment and combine MAs with tools like support and resistance, volume analysis, or momentum indicators. And (of course) always apply sound risk management — define your stop-loss, position size appropriately, and never trade based solely on hope.

Putting it all into practice

The best way to understand moving averages is to practise with them in a risk-free environment. Here's a step-by-step exercise using a demo account:

1. Open a demo account.
   

2. Choose a well-trending asset to practise with. Good options include:
   • Major forex pairs (EUR/USD, GBP/USD, USD/JPY)
   • Popular stocks (Apple, Microsoft, Tesla)
   • Index funds (S&P 500, NASDAQ 100)

3. Set your chart to a daily timeframe (this reduces market noise and makes trends clearer for beginners)

4. Add the following moving averages to your chart:
   • 20-period EMA (short-term trend)
   • 50-period SMA (medium-term trend)
   • 200-period SMA (long-term trend)

5. Identify the overall trend by looking at your chart and answering these questions:
   • Where is the current price compared to each moving average (above or below)?
   • Are the MAs stacked (bullish or bearish)?
   • What direction is each moving average sloping (up, down or sideways)?

What you should see: In a clear uptrend, price will be above all three MAs, with the 20 EMA on top, 50 SMA in the middle, and 200 SMA at the bottom. In a downtrend, this order reverses.

6. Look for crossovers and key signals. You may have to scroll back through several months of price history and look for:
   • Golden crosses: Where did the 50-day cross above the 200-day? What happened to price afterward?
   • Death crosses: Where did the 50-day cross below the 200-day? How did price react?
   • Shorter-term crossovers: Find where the 20-day crossed the 50-day in either direction

What you should see: These crossovers often (but not always) coincide with significant price moves. Note that the signals come after the move has started—this is the "lagging" nature of MAs.

7. Test moving averages as support and resistance. Look for points where:
   • Price bounced up from a moving average (acting as support)
   • Price was rejected down from a moving average (acting as resistance)
   • Price broke through a moving average decisively

8. Assess trend strength:
   • Are the three moving averages spread far apart or bunched together?
   • Is price making consistent moves in one direction, or bouncing around?

What you should see: Wide spacing between MAs usually indicates a strong trend. When MAs start converging (coming together), the trend may be weakening.

Practice tip: Try this exercise with 3-4 different assets across different market conditions. You'll start to see patterns in how moving averages behave in trending versus sideways markets.

Once you’re comfortable with MAs, you can begin to incorporate them into your trading plan. They may be considered simple tools, but when used in context (with proper risk management), they can offer helpful insights into trend direction, momentum, and trading opportunities.

In the next lesson, we look at oscillators and how they help us understand overbought and oversold trading conditions.