Shallow Pullback to 10-day MA in uptrend

Moving averages are one of the most useful tools for traders who want to identify the main trend of the equities and futures markets. Forex trading patterns are similar to those of equities and futures and trading patterns. Therefore, moving averages, RSI, historical volatility and almost every other technical indicator can be applied just as easily to the Forex markets as they can the stock market.

With that said, let's take a look at how Forex traders can use a 10-day simple moving average (SMA) to gauge pullbacks. Pullbacks occur when a trending stock pulls back against the trend, resting for one or more bars before continuing in the direction of the trend. From September '05 to November '05 the U.S. Dollar held a consistent, long term rally against the Yen (USDJPY), when the Dollar continued to find support at the 10-day SMA due to a short-term oversold condition. Such a consistent, patterned trade gives traders numerous opportunities to buy on pullbacks to the SMA, which would give trend traders a better buy-in price. The rally started in the beginning of September as price broke above the 10-day SMA and closed above for a few days in a row. As we count them, USDJPY made five pullbacks to the 10-day SMA after starting the rally. Looking at the chart, you'll see five separate opportunities to get a better price to catch the move up.

So when to exit? Some might say, "Exit when price closes back below the SMA." That might work well, except for the fact that price repeatedly closed beneath the MA, only to set up classic reversal bars as the pullback resumed the trend. Looking at the chart below, we see that the major reversal at the end of the rally occurred after price closed under the SMA for two straight days, not just one. There are many potential ways to enter and exit these pullbacks. We recommend that you plot the 10-day SMA on your own charts and determine which approaches work best for you.

Here is another example of GBPUSD running pullbacks as the price continues in an uptrend.

Try using pullbacks to the 10-day simple moving average to get a better price in an uptrend. The 10-day SMA is a relatively short-term indicator, but price support can be found there, giving traders a great point of reference when trying to optimize a pullback trade.

John Patrick Lee
Associate Editor
johnl@tradingmarkets.com