A Moving Average is Like a Trampoline
Moving averages are like trampolines, sorta. Price action hits them and bounces away, then drops back and bounces again. That’s pretty much where the analogy ends. Because the trampoline moves toward the price action as well. And of course, sometimes the price action will go right through the trampoline and start bouncing on the other side. So, I guess moving averages aren’t really like trampolines at all. But the point is still the same, price moves away, moves back to the moving average, bounces away again and so on, until it finally breaks through and starts bouncing on the other side of the moving average.
With any trading strategy, the idea is to notice a pattern, then figure out a way to use it as an edge to conquer the market.
What Is A Moving Average?
The term moving average pretty well describes what it is. An average that moves with the price action. There are several types of moving averages in common use. For brevity’s sake, I’ll only mention the two most common: The Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
SMA vs EMA
The SMA (that I prefer to use) simply adds all the closing prices together for the last x candles and places a point at the average of that number. The EMA, sometimes called the Exponentially-Weighted Moving Average, averages all the closing prices together for the last x candles, but weights the more recent candles exponentially so the average moves more quickly with price action.
The Moving Average Bounce Strategy
The Moving Average Bounce Strategy is a simple strategy to take advantage of the price action that occurs in conjunction with the moving averages.
We’ve tested this strategy on the EUR/USD Hourly chart. It should work on any trading instrument and time frame that you prefer, but you should do your due diligence to determine what variables will work best with your chosen setup. The variables with which you will want to work are the fast moving average, the slow moving average and the take profit amount.
For the EUR/USD Hourly chart, we’ve determined that a simple moving average of 21 bars works well for the fast moving average. A simple moving average of 100 bars works well for the slow moving average. And a take profit of 20 pips works well for this strategy.
The Strategy Setup
All examples will take place on the EUR/USD Hourly chart. Again, study your trading instrument and time frame for the proper variables to be sure you can be profitable with this strategy.
Open your EUR/USD Hourly chart and place the 100 period simple moving average (on the close) and the 21 period simple moving average (on the close.)
I’ve used Blue for the 21 period SMA and Brown for the 100 period SMA.
Rule #1 – You will only enter long positions when the 21 SMA is above the 100 SMA. Conversely, you will only enter short positions when the 21 SMA is below the 100 SMA.
Rule #2 – You will enter your position when the price action touches the 21 SMA.
Rule #3 – You will take profit when your trade hits 20 pips.
Rule #4 – You will take your stop when your trade touches the 100 SMA.
Rule #5 – You will take only one position at a time.
Here is a Moving Average example of a winning trade:
Notice the 21 SMA is below the 100 SMA, so according to the rules, we can only go short.
Here is an example of a winning long trade after the moving averages have crossed over:
Here is an example of a losing long position:
You may note that the examples of losses are larger than the wins since we are taking 20 pip profits on wins. That’s not always the case, but there seem to be two to three or more wins to each loss during trending times when the 100 SMA is farther away (causing larger losses on crossover.) In consolidations, there are fewer wins per loss, but the losses are much smaller because the 100 SMA moving average is closer to the price action during a consolidation period.
The following image shows a series of trades over a few days time. Note the win/loss ratio during the trending times when the losses are larger and the loss size during the consolidation times when there are fewer wins per loss.