Moving averages are like trampolines, more or less. The price action hits them and bounces, then backs off and bounces again. That is more or less where the analogy ends. Because the trampoline also moves towards the price action. And, of course, sometimes the price action will go through the trampoline and start bouncing on the other side. So, I guess moving averages are not like trampolines. But the point remains the same, the price moves away, returns to the moving average, bounces again and so on, until it finally breaks and begins to bounce on the other side of the moving average.
With any commercial strategy, the idea is to notice a pattern, then discover a way to use it as an advantage to conquer the market.
What is a moving average?
The term moving average describes very well what it is. An average that moves with the price action. There are several types of commonly used mobile averages. For the sake of brevity, I will only mention the two most common: the simple moving average (SMA) and the exponential moving average (EMA).
SMA vs EMA
The SMA (which I prefer to use) simply adds up all the closing prices of the last x candles and places a point on the average of that number. The EMA, sometimes called the exponentially weighted moving average, averages all closing prices of the last x candles, but weights exponentially the most recent candles so that the average moves faster with the price action.
The bounce strategy of the moving average
The bounce strategy of the moving average is a simple strategy to take advantage of the price action that occurs along with the moving averages.
We have tested this strategy in the EUR / USD hourly chart. It should work in any commercial instrument and time frame that you prefer, but you must do your due diligence to determine which variables will work best with the chosen configuration. The variables you will want to work with are the average fast movement, the average slow movement and the amount of profit.
For the EUR / USD hourly chart, we have determined that a simple 21 bar moving average works well for the fast-moving average. A simple 100 bar mobile average works well for the slow-moving average. And a profit of 20 pips works well for this strategy.
The strategy configuration
All examples will take place in the EUR / USD hourly chart. Again, study your business instrument and the time frame for the appropriate variables to ensure that you can be profitable with this strategy.
Open your EUR / USD hourly chart and enter the simple moving average of 100 periods (at closing) and the simple moving average of 21 periods (at closing).
I have used Blue for the 21 periods AME and Brown for the 100 periods AME.
Rule # 1: Only long positions will be entered when the 21 SMA is above 100 SMA. On the contrary, it will only enter short positions when the 21 SMA is below 100 SMA.
Rule # 2: You will enter your position when the price action touches SMA 21.
Rule # 3 – You will make a profit when your trade reaches 20 pips.
Rule # 4 – You will stop when your operation touches the 100 SMA.
Rule # 5: You will only take one position at a time.
Here is an example of a moving average of a winning operation:
Note that SMA 21 is below SMA 100, so according to the rules, we can only fall short.
Below is an example of a losing operation according to our rules. Trade is short because 21 SMA is below 100 SMA. When the price action touches the SMA 100, this operation is closed for a loss of 30 pips.
Here is an example of a long winning operation after moving averages have crossed:
Here is an example of a long losing position:
You can see that the examples of losses are greater than the gains since we are obtaining 20 pip of gains in profits. That is not always the case, but there seem to be two or three or more wins for each loss during the trend times when the 100 SMA is farther away (causing greater losses at the crossing). In consolidations, there are fewer wins by loss, but the losses are much lower because the moving average of 100 SMA is closer to the price action during a consolidation period.
The following image shows a series of operations in a few days. Take into account the profit/loss ratio during trend times when losses are greater and the size of the loss during consolidation times when there are fewer gains for loss.
As always, do not negotiate excessively (take all signals, but do not use a size too large for your positions). Be sure to maintain your risk parameters. Be safe and have fun.