Investors have always loved using indicators. It is worth using them both in day trading and in medium-term trading. Unfortunately, often, instead of focusing on a specific indicator and making it the base, traders test many of them, which is worse on one chart. This generates conflicting signals, making effective trading impossible. The Moving Averages Crossing Strategy can be an uncomplicated and effective method of making a profit .
The strategy of crossing the moving averages and its tools
The only tool used in this strategy is the Exponential Moving Average . It is a weighted average, its weights vary exponentially. It is calculated on the basis of a formula that gives the higher weight to the current periods and the less weight to the distant ones. Each period has a different weight.
For example, with an average of 5 periods, the price that is 5 periods away from the current one will be the least important, and the last one will be the most important. As a result, the EMA runs closer to the price than the simple moving average and is more responsive to strong movements in the chart – the latest changes have a greater impact on it.
In this strategy we will use as many as three EMA averages, 5-period and 13-period will signal when to enter the position. Why such periods? They result from the Fibonacci sequence and professional and institutional traders usually rely on them when trading with this strategy, making them a self-fulfilling prophecy.
The third average is the 200 period EMA and will be used to identify the trend. The strategy of crossing the averages works in principle at every time frame, but this time we will focus on day trading and we will use the M5 chart.
Moving Averages Crossing Strategy – Entry
When trading with the rules of the Crossover Strategy, you should never fight the trend. Our goal is to follow the current trend and seize the opportunity to join it.
Let’s start with a long position . To open it, the following conditions must be met:
- The previous candle turned out to be up and the new one opened with another upward move
- The current price is above the EMA 200 average
- The average EMA of 5 crosses the average EMA of 13 from below
Here we have an entry under the conditions described above, opening price 108,152 (spread costs must be added).
Now let’s move to the short position . We open it when the following conditions are met:
- The previous candle turned to bear down and the new one opened with another downward move
- The current price is below the EMA 200 average
- The 5 average EMA crosses the 13 average EMA from above
The above entry complies with the described conditions, opening price 1.08662.
Moving Averages Crossing Strategy – Exit
The most important issue in any successful trading strategy is capital protection. So, in the crossover method, start by designating a Stop Loss Order . It should be located:
- Just below the average EMA 200 in the long position
- Just above the average EMA 200 short
However, if the chart is too many pips from the above-mentioned average, you should set a Stop Loss order to limit the risk level:
- The preceding candle in the long position
- Above the preceding candle in the short position
We open such a position only if the loss does not exceed the percentage value of the deposit assumed by us.
On the other hand, Take Profit should be set at a distance three times greater than the Stop Loss from the opening price, thanks to which we have a very favorable profit / risk ratio.
Example of closing a long position:
The stop loss was at 1.08120 and the position should be closed at 1.08242.
Example of closing a short position:
The stop loss was at 1.08690 and the position should have closed at 1.08590 (spread costs should be added).
The strategy of crossing the moving averages and capital management
Money management is a key issue in the operation of any strategy. If a trader mishandles his own capital, he is on the way to incur huge, irreversible losses on his own investment account.
However, in the case of the method of crossing the averages, the potential profit is usually three times greater than the risk of loss on each trade . This is due to the strict rules for determining Stop Loss and Take Profit levels. Thus, the investor should not worry about a severe depletion of funds, even in the event of a series of unsuccessful entries.
This does not change the fact that, according to the literature on risk control, the value that a trader is willing to lose should not exceed 2% of his / her own deposit on a single position , especially since using this strategy you can include several of them every day. In such a situation, only the occurrence of a streak of 194 unsuccessful transactions would cause the account value to fall below 2% of the starting capital. With such assumptions, the probability of bankruptcy is close to zero.