The moving average is a common tool utilized by forex traders to aid in making trading decisions. The moving average crossover strategy is a popular technical strategy which provides trade signals when shorter-period moving averages crossover longer-period moving averages. However, there are also various other strategies available that utilize moving averages. The moving average ribbon is one strategy used by traders as an alternative or enhancement to the simple crossover strategy.
Trend Strength and Reversal Confirmation
Moving average ribbons take the moving average crossover strategy to the next level by using more than three moving averages. Traders using this strategy will place numerous moving averages onto the same forex chart. This enables traders to better judge the strength of a current trend, which is considered strong when the moving averages are all heading in the same direction. Traders also confirm reversals when the moving averages cross over and begin to move in the opposite direction.
Responsiveness
Traders can customize the responsiveness of the moving average ribbon trade signals to fit their own risk profiles. They do this by adjusting the number of time periods utilized in the moving averages. Shorter time periods tend to be more sensitive to minor price changes.
One of the most commonly used strategies is to start with a 50-period moving average and then add moving averages in 10-period increments until reaching the final moving average of 200 periods. This moving average ribbon is known for identifying longer-term trends and reversals when plotted on longer-term time charts, such as daily or weekly charts. Traders who want a more sensitive moving average ribbon can begin with a shorter period average, such as a 10-period moving average.
On the other hand, how a forex trader uses the moving average ribbon strategy will depend upon his or her risk tolerance. Those traders who wish to aim for larger gains and are comfortable with the increased risk associated may want to use a more responsive moving average ribbon. More risk averse traders will want to use a less responsive ribbon.
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Sources:
http://www.investopedia.com/university/movingaverage/movingaverages4.asp
