Moving averages are commonly used by beginner traders. This is because they are easy to calculate, understand, and incorporate into one’s trading strategy. And since they use actual forex market data, using them to analyze price movements tends to help in reliably predicting future price movements.
However, as a beginner, it is important to know that over-reliance on moving averages can lead to wrong predictions. Even sound trading strategies that are based on moving averages can lead you to losing money simply because moving averages have limitations. Here are the ones that you should be aware of.
Limitation on ability to predict future currency pair prices
The main limitation with regards to moving averages lies in the fact that it relies on past data. It does not provide room for any future changes and so when sudden changes occur, a trader can end up getting their predictions wrong. This normally happens in cases where a credible competitor enters into a market. Things like a sudden change in leadership, catastrophic weather elements or unexpected shifts in demand and supply, can also change the reliability of moving averages.
In short, in any scenario that features a significant departure from the past, it is impossible to get it right when using moving averages. Why? Because moving averages depend on historical data. As a result, any signals that you get from using them during periods of uncertainty, are likely to be either useless or misleading. It also means that one will have to use the metric sparingly because it is only useful in cases where there is a degree of stability.
Limited opportunities for effective use
Moving averages are only effective when one is working with strongly trending markets. Even for slightly trending markets, using moving averages to identify and take advantage of opportunities can prove to be futile.
For a beginner, this presents a problem. For starters, your trading opportunities will be limited. This is because you can only use this indicator effectively only some of the time. This is because when you limit yourself to using the moving average, your opportunities will only tend to be limited to markets that are strongl;y trending as they are the ones where these indicators are useful. Trying to use it in a market that isn’t trending will only leave you with confusing signals. Relying on these signals will do nothing other than increase your risks of ending up with losses.
Therefore, given that trending markets only tend to occur in about 20% of the cases, beginners who choose to rely on them will only be able to get great trading opportunities 20% of the time. And since making smaller trades in larger volumes is sometimes the ideal strategy for beginners, this can mean lower profits.
No consensus on the ideal moving average to use
When you are starting out, having a simplified path to profitability can be quite encouraging. This is so especially if you have no interest in soaking your brain with trading jargon and technicalities. And while moving averages offer a degree of simplicity for a beginner, there isn’t a consensus as to which moving average is the best. While some analysts swear by the efficacy and effectiveness of exponential moving averages, others advocate for simple moving averages as the ideal average for analysing chart data.
For beginners, this presents a problem because it can cause them to become paralysed with the decision of what to choose. It may also be tempting to move back and forth between the averages, and this may lead to a confused trading strategy. In short, the mere fact that there isn’t a consensus among analysts places the burden of chart interpretation, analysis and evaluation, on newbies. This can make the trading process overwhelming.
Even with these shortcomings, moving averages are still widely used. This is because under the right conditions, they regularly prove to be beneficial in interpreting market data. This is so especially when it is used together with oscillators and other indicators. Therefore, while these indicators should make you cautious when using moving averages, they shouldn’t make you shy away from using them. Using them when starting your trading journey can still help you to find winning trades.