Do crossover moving averages strategies really work?
Moving price average trading strategy
Forex trading strategies with the moving average price
Moving Average: use of the indicator
The trend recognition in the Forex market is an important criterion for the success in trading. There are many indicators that should help you estimate the direction a price is heading. The trading strategy of the moving average (moving average) is most often used. This indicator helps you to determine the trend direction and possible setbacks, as well as to recognize a trendless phase. How is that achieved?
The Moving Average (MA) is a trend indicator and a trading strategy, represented by a curved line. It is calculated based on the price data. Accordingly, the moving average is used by traders to confirm trends. In the chart you can see how the moving average tracks the price movements of an asset, but in a smoother form.
In the example you can see how a trend can be recognized with the indicator:
The first example shows how a security rising in price has formed a trend and that this is confirmed by the moving average. The opposite situation, i.e. a downtrend, is demonstrated in the following example.
Moving Average: characteristics of the indicator
At any point, the MA's value is exactly the average price of the security at a given time. Sometimes it is the arithmetic mean and sometimes more complicated formulas are used to calculate it. The period length is the most important parameter of this indicator because it determines how many points in time should be included in the average.
There are four main types of MA.
- Simple: Its values are the arithmetic mean of the price.
- Exponential: In this case, the latest prices in a period are weighted more heavily than older ones. The weight is determined using an arithmetic series.
- Linear: Here, too, the last values have a higher weight, but the values are calculated geometrically.
- Smoothed: The more recent values are also given a higher weight and additional values are taken into account that are not recorded by the actual period length.
In MetaTrader 4 it is very easy to add this indicator to a chart. This can be done via the “Insert” tab by selecting “Indicators” and then “Moving Average”. Alternatively, you can simply select the corresponding icon in the menu bar.
To customize the indicator, all you have to do is right-click it and select the “Properties” button.
In the window that appears, you can see the various settings of the indicator, where you can change the following.
- Period length
- MA method (exact type, for example simple or smooth)
- Calculation basis (should the indicator be calculated on the basis of closing or opening prices, etc.?)
- Style (color, line width)
You can also select the display of different time units in the settings.
The vast majority of trading strategies use simple moving averages. They are selected by default, unless otherwise set in the respective trading platform. Let's take a closer look at the individual types of moving averages.
Types of moving averages
Simple moving average
The simple moving average (short SMA for S.imple M.oving A.verage) is a line drawn through points, the value of which is calculated as the arithmetic mean of the previous prices. The longer the period is set (the number of values that are taken into account), the smoother it runs and the further it moves away from the price trend.
For example, if on a daily chart the closing prices for the last five days are 1.2; 1.3; 1.2; Were 1.5 and 1.6, then the next day the moving average would have a value of 1.36. In order to calculate the next but one value of this 5-period MA, you would now have to remove the 1.2 and append the new value after 1.6.
To add a simple moving average to a chart, you must first select the moving average tool from the pool of indicators provided. A configuration window then opens in which you have to select “simple” for the MA method. The following settings then depend on your trading strategy (hereinafter referred to as TS).
The simple moving average is the most popular indicator among all MA variants and many trading strategies are based on it. Despite the fact that most trading strategies add additional indicators to the MA, there are also TSs that are designed for use on their own. The most reliable trading strategy of these is the use of the SMA in the chariot technique.
The Chariot technique was developed for medium and long-term trading and is ideally suited for the D1 or W1 chart. You can also use the strategy on an hourly or 4-hour chart, but the larger the time window, the clearer the trend is to read. And trading a trend is the key to being successful in chariot trading.
A simple MA with period 40 is used as a signal generator.
A trade is then entered into based on the following rules.
- If the asset price crosses the moving average from below and the candle closes above the MA, then you can buy with the opening of the next candle.
- If, on the other hand, the price crosses the MA from above to below and the candle closes below the moving average, then you should sell or go short.
The stop loss is placed below the low (or above the high) of a breakout candle. Profits can be realized via a take profit order (for example by choosing the distance to the price three times as large as the distance to the stop loss) and with the help of a trailing stop.
The Chariot technique is one of the older trading strategies. However, although it is used in its original form with no oscillators, some traders add tools such as the ADX to it. The Chariot technique delivers excellent results with the trend. But if you want to minimize the number of trades within the "flotation period", then it makes sense to use an additional filter indicator.
Exponential moving average
The calculation of the values of the expontential M.oving A.verage (EMA) differs from that of the simple, because the last values have a higher weight than those further back. The formula for calculating the EMA is quite complicated, but in essence it says that the last price has the highest weight in a 10-period EMA, while the closing price of the tenth to the last candle is practically ignored.
This moving average is designed to allow a smoother transition from one time window to another. By reducing the influence of those prices that are no longer included in the MA in the next period, the problems of the simple MA are solved. Because now omitting the last value has a significantly smaller effect on the price than adding a new one. As a result, the EMA's trend is significantly smoother than that of the SMA and is also closer to the real price trend. In addition, large price movements that are further in the past have less of an impact.
The exponential moving average is based on the same principle as the simple one, but you have to select the specification "Exponential" when choosing the "MA method" in the settings window of the indicator used.
Many Forex trading strategies that use the SMA are also relevant to the EMA. Sometimes professional traders modify classic TS by not only changing the period length but also adapting the MA method, for example by replacing the SMA with the EMA. After the version has been tested and adjusted, such a changed strategy can actually turn out to be more profitable than using a simple MA.
For example, imagine a trading strategy that uses a number of EMAs along with oscillating indicators. This is a classic combination of a trend indicator that shows the direction of development and the oscillator that should indicate the optimal entry point.
The trading strategy works on any time horizon, but it is mostly used for short-term trades on the M15-N1 chart.
Buy orders are placed when the indicators show the following trading signals.
- The price crosses the EMA from the bottom up.
- The histogram of the AO indicator crosses the zero line from bottom to top.
A short position is entered if the opposite is the case.
The system is simple and there are no strict rules for exiting the trade. So the dealer has some freedom here. You can leave the position open until signals to the contrary appear, or you can place stops and take profit orders. In the latter case, the ratio should be at least 1: 3 in favor of the take profit order.
Linear weighted moving average
As with the exponential moving average, the weight for the values from the near past is higher than that of the values further back. But the weight of the linearly weighted moving average (WMA for short W.eighted M.oving A.verage) is based on arithmetic rather than geometric progression. For a 5-period MA, the weight of the last price is 5, for the penultimate 4, and so on to 1.
The WMA can be set in the same way as the previous moving average. You only have to select the entry “linearly weighted” for “MA method”.
So far there are few trading strategies that use the linearly weighted moving average. For the few, it is considered to be advanced TS that are the result of many experiments and modifications of simple systems.
For example, think of a strategy with a WMA, the RSI and the MACD. This trading strategy is intended for medium-term trading on a daily chart, with the optimal asset being the EUR / USD currency pair.
To execute the strategy, you need to set the parameters of your trading chart as follows.
- Five weighted moving averages with periods 5, 15, 30, 60 and 90.
- Oscillator RSI with period 5 and levels 40 and 60.
- MACD with periods 5 and 13 for a fast and a slow EMA (SMA remains at standard). In addition, the levels 0.005 and -0.005 are set.
The strategy generates a sell signal when the following conditions are met.
- The fastest WMA (with period 5) intersects the WMA with period 15 and both are below the other moving averages.
- The RSI line is hovering in the overbought area (above 60) and crossing this line from above.
- The MACD histogram rises above the 0.005 level and then rotates in the other direction.
A buy signal is generated when the opposite conditions are met.
This trading strategy was developed many years ago by Western traders and has received many positive reactions from the professional world. Nevertheless, some exports believe that three WMAs with periods 30, 60 and 90 are superfluous in this strategy, since the quality of the signals would not change if they were removed.
Once again, the exit is left to the trader, although setting a stop is part of risk management under all circumstances. The loss threshold can be set at the minimum or maximum of the signal candle and at the next support or resistance line.
Smoothed moving average
The construction of the smoothed moving average differs significantly from the previous modifications. Because not only the prices within the specified period are taken into account, but also n values further back. Although the weights outside the period are significantly lower than the newer values within the period, they still have an influence on the final value. While the exponential and linear weighted moving average are smoother and closer to the price, the smoothed moving average moves further away from it.
The selection and setting of the indicator are carried out in a similar way as before. Period, shift and style can be set by the trader after the MA method has been set to "smooth".
Compared to the other variants, the smoothed moving average is the least known and is therefore rarely used in trading strategies. In general, the smoothed MA is used in complex auto trading software and is also used in individual indicators.
Trading with moving averages
Moving averages are a universal tool. They are suitable for online trading at all time levels and for all securities. There are many techniques and trading strategies using these indicators. Let's consider the simplest.
Trading with an MA
The simplest and most general technique works with just one indicator that generates the signals to open a position at the intersection with the price trend.
- If the price crosses the MA line from the bottom up, then this is a signal for a buy position.
- If, on the other hand, the price crosses the moving average from top to bottom, then a signal to open a short position is generated.
The disadvantage of this procedure is the large number of false signals. A moving average can help trade the big trend, but many unprofitable trades could be opened beforehand. It is therefore important to work with tight stops so that losses are small and the large profit can compensate for them.
Trading with two moving averages
This method is similar to the previous one, but a second MA with different parameters is used. Signals are generated here by the intersection of both indicators.
- If the fast MA crosses the slow MA from bottom to top, then a buy signal is triggered.
- If, on the other hand, the fast MA cuts the slow MA from top to bottom, then there is a sell signal.
As you can see in the example, the second moving average means that many false signals have already been filtered out. However, this increased the problem of delay - the signal often only comes when half of the movement has already passed.
Moving Average with MACD
The MACD is an oscillator based on two moving averages and their intersections. In connection with another employee, it acts as a filter.
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