Day Trading & Forex Forum

Figure 2. There are two divergence instances between the euro/sterling and its 25-day moving average; the cross traded sideways and this allowed the average to get closer to the pair. (click to enlarge)

Another way to alleviate the overbought condition is for the pair to fall and intersect the lagging average.  In Figure 3, the overbought dollar/yen formed a bearish candlestick reversal signal at the highest point of the chart and then headed straight down to reach its 25 day moving average.

Figure 3.  The overbought dollar/yen formed a bearish candlestick reversal signal at the highest point of the chart and then fell to reach its 25 day moving average. (click to enlarge)

The divergence between a currency and its moving average on the daily charts tends to provide a short-term divergence signal. To identify medium-term overbought or oversold conditions, traders use either a weekly currency and its average, or they compare two moving averages plotted on the daily charts.

Figure 4 shows two instances where the Australian dollar was overbought versus the US currency on a weekly basis (see red arrows) and two examples where it was oversold (blue arrows).

Figure 4.  The Australian dollar is overbought versus the US currency on a weekly basis. (click to enlarge)

Figure 5 shows the daily sterling/dollar being oversold.  The first blue arrow points a short-term oversold condition, as defined by the distance between the currency pair and the 20-day moving average (which is denoted by a green line).  The currency promptly approached that average and alleviated this condition.   By the time sterling/dollar reached the area of the second blue arrow, it was close to the 20-day moving average, but that average was too far away from the 50-day moving average.  The signal to attempt alleviating this medium-term oversold condition was given by the upward crossover of the sterling/dollar above the 20-day moving average.  The red arrow points to a short term overbought example.