Forex Dreamers

200 simple moving average strategy

“Moving Averages” is wildly popular among traders. They help me clearly define the trend and its strength while remaining objective to the market. In this article, I will try to describe as thoroughly as possible four trading strategies for moving averages, consider the types of moving averages, and, of course, all this will be backed up by examples of real transactions and many valuable recommendations.

Moving Average is an indicator of trend trading, which calculates the average price value for a selected period. We have conducted VERY detailed tests of this indicator and made a separate article with the results, many of which were surprising!

What gives the average price value:

• exclusion of “noise” and periods of high volatility from the chart;
• revealing the true direction of the price (trend);
• simplification of graph interpretation.

In practice, working with this indicator looks like this:

Such a calculation can be performed using different formulas depending on the type of moving average described in more detail below.

Types of moving averages

In total, there are four main types of moving averages, which are presented in almost all trading terminals:

• simple (SMA or Simple Moving Average);
• exponential (EMA or Exponential Moving Average);
• smoothed (SMMA or Smoothed Moving Average);
• linearly weighted (LWMA or Linear Weighted Moving Average).

Let’s consider each of them in order.

Simple moving average

SMA, Simple Moving Average, is calculated using the following formula.

Within the formula:

t is the period of the moving average;

n – the number of candles (bars) on the selected interval for calculation;

A – price for the specified period (as a rule, the Close price is taken into account, i.e., close, but you can change this parameter to Open, High, Low, etc. in the indicator settings);

Simple moving average (SMA) example on the chart.

Pros of SMA:

• the easiest calculation method;
• all price values, early and late, are given an equal value (unlike other types of the moving average) – in trading, it can be both an advantage and a disadvantage, depending on the situation.

Cons of SMA:

• a relatively high degree of influence of market noise on the readings of the average results in more false signals.

In general, SMA is a standard variety that is used by default in all trading terminals. In moving average trading, most traders consider it less effective. As a result, they prefer to change the settings and choose other construction methods, although there is no evidence.

Exponential Moving Average

The next type is EMA, an exponential moving average, which is calculated using a different formula.

Similarly, within the framework of the formula:

t is the period of the moving average;

A – price for the specified period (as a rule, the Close price is taken into account, i.e., close, but you can change this parameter to Open, High, Low, etc. in the indicator settings);

r = 2 / (n + 1), where n is the number of candles (bars) on the selected interval for calculation;

EMA0 = A0.

An example of comparing EMA (50) and SMA (50) on the chart.

As you can see, the EMA values ​​differ significantly from the SMA, and the longer the period of the average, the more visible the differences.

Pros of EMA:

• more importance is attached to the last (current) prices on the chart, which makes the EMA more relevant in comparison with the SMA;
• on the chart, the EMA looks less smooth, which makes it possible to increase trend detection speed.

Cons of EMA:

• at the same time, due to a lower degree of smoothness, there are many false signals to enter a position.

EMA is considered the most popular variation of the moving average in trading. It is used on charts more often than others. There are even separate communities of traders trading two EMAs with 7-day and 14-day periods. I also prefer to use EMA in trading, which I will clearly show in interesting examples along the way.

Smoothed Moving Average

The Smoothed Moving Average (SMMA) formula looks like this.

Within the formula:

t is the period of the moving average;

n – the number of candles (bars) on the selected interval for calculation;

A – price for the specified period (as a rule, the Close price is taken into account, i.e., close, but you can change this parameter to Open, High, Low, etc. in the indicator settings);

SMMA0 = A0.

Differences between SmMA, EMA and SMA on the chart.

SMA differs significantly from the previous variations in its smoothness, as you might guess from the name.

Pros of SmMA:

• the minimum number of false signals and “noise” due to smoothness.

Cons of SmMA:

• a signal about the beginning of a trend appears much later;
• strong short-term trends are completely overlooked.

SmMA is an effective calculation method, but only in combination with others to determine a more global movement. SMMA is not very popular among traders, at least in comparison with EMA.

Linearly weighted moving average

The final plotting method is Linear Weighted or LWMA. Its formula is presented below.

Within the formula:

t is the period of the moving average;

A – price for the specified period (as a rule, the Close price is taken into account, i.e., close, but you can change this parameter to Open, High, Low, etc. in the indicator settings);

n – the number of candles (bars) on the selected interval for calculation.

To clutter up the chart with four construction methods at once, we will divide the practical material into two parts. Compared to SMA and SMMA on the LWMA chart, it looks like this.

As you can see, the LWMA is smoothed less than the indicated moving averages, but the LWMA method is also different from the Exponential Moving Average.

You can see that LWMA is even less smoothed than EMA, which makes this plotting method much more sensitive.

Pros of LWMA:

• the latter prices are given more weight in comparison with all other MA types. As a result, the indicator is less lagging;
• allows you to identify strong short-term trends.

Cons of LWMA:

• the maximum number of false signals in the sideways direction, even in comparison with the EMA.

LWMA is an interesting method for the most sensitive trend search but not the most popular in the trader community. Likely, the number of false signals when trading on this moving average influenced because even the speed of reaction to market changes should be moderate.

There are a lot of different trading strategies using moving averages. However, I can distinguish four main trading variations:

• at the intersection (breakout) of the moving average price;
• at the intersection of two or more averages;
• on a false breakout of the moving average;
• on the return to the average (there will be examples of real transactions).

The list is not closed because it is indicated without considering the possibility of combining with other indicators (see the full list of tested ones here), for example, oscillators or volume. About each strategy in order.

Price crossing (breakout) of the moving average

The easiest strategy is to cross the SMA (200). We note right away that such a strategy does not bring profit to Forex in the long term. The idea is simple:

Also read  MACD and Stochastic Strategy in Forex

The price breaks the SMA from bottom to top, enter the long;

The price breaks the SMA from top to bottom and enters the short.

The exit is carried out after a new intersection of SMA (200). An example of entering a trade according to the conditions on the chart.

The system is far from the most effective. As a rule, more or less high-quality signals are available only on daily charts and higher, and there is too much noise on small timeframes. I have not used such strategies for a long time since they are more intended for those who have little experience trading purely for informational purposes.

Cross of two moving averages

Another variant of the simplest and not the most effective strategy using moving averages is the intersection of two or more MAs. For example, you can take the EMA mentioned above (7) and EMA (14).

Idea – EMA (7) crosses EMA (14) from top to bottom. We enter short, if, on the contrary, we enter long. If you cross again, exit the position.

On the chart, an example of trade will look like this.

EMA crossover is similarly a very simple but unprofitable trading strategy. For a long time, I have tested the crossovers of various MAs with various parameters, and they both bring large profits and give considerable losses. The highest efficiency of crossovers is also possible only on large timeframes (from D1 and higher). Also, you will need additional entry filters; otherwise, there will simply be only losses.

Moving Average False Breakout

If the usual breakdown of the average does not work effectively, then it is logical to assume that you can act the other way around, immediately expecting a deception from the market. This approach is called the moving average false breakout strategy. Its essence:

• after the breakdown of the EMA (200), expect the price to return back and only then enter the deal;
• exit the trade after the breakout of the EMA.

Example of the chart.

As you can see, a 5-minute timeframe is used for the entry. This strategy shows itself better within the day, and on larger intervals, the efficiency is lower.

From my experience, I can say that with such a strategy, you can make little money. Still, it is quite difficult psychologically because there will be many unprofitable trades that will overlap with one super-profitable one in the trend. This strategy should not be used in the long term since it does not show particularly positive results during testing.

One of the non-standard uses of MA is trading retracements to averages. The essence is as follows:

the trade is entered against the trend when the price moves too far from the EMA (21);

exit from a position when the price reaches the EMA (21) values, or earlier by several points.

Back to MA is used by many professional algorithmic traders, but the strategy needs a lot of experience and effective filters. Of great importance is the understanding at the level of intuition, when the signal is valid, and when not, is it worth averaging, etc. I could trade on such a system with a plus with averaging, but losses are also part of the system and must be fixed in time. It will be difficult for a beginner to control risks (what should they be in general?), And in general, the system is too risky.

How to choose the period for trading on the moving average

This is a very popular question among novice traders. An understanding of a simple fact helped me: the average number is the number of candles on the timeframe, according to which the formula will be calculated (which I wrote about in the theoretical part at the beginning of the article). Examples:

MA (12) on a 5-minute interval – average values ​​over 60 minutes, i.e. 1 hour, it is equal to MA (4) on 15 minutes, MA (2) on 30 minutes, etc.

MA (288) at 5 minutes is the average value for one day, which is equal to MA (24) at the hourly and MA (6) at the 4-hour interval.

The average period depends on how long you are willing to hold the trade. Let’s say we plan to hold a deal for 1 hour, then MA (12) on a 5-minute chart will suit us because these are the average prices for 60 minutes. Otherwise, we want to hold a position for 1-2 weeks. The EMA (7) and EMA (14) on D1 are just suitable for this, but it is more correct to use periods 5 and 10 because there are only five trading days in a week, and weekends are usually skipped on charts.

It’s even easier to choose popular round numbers for the MA period: 10, 20, 50, 100, 150, 200, etc. The most famous are the values ​​of 100 and 200; many technical analysts are guided by them in professional sources abroad (for example, in Bloomberg and others).

Moving averages in the stock market

Moving averages are much more important in the stock market. The reason lies in the difference between the OTC Forex market and exchange-traded instruments:

on Forex – the ratio of the economies of the two countries is unpredictable and constantly changing. As a result, currency pairs often change direction, without a tendency to constantly grow or fall in the long term;

in the stock market – shares of successful companies and indices are steadily growing and more predictable. Only during periods of crisis do large bearish movements begin.

It turns out that the stock market, with a few exceptions, is a pure trend, while the Moving Average trend allows you to make money. Let’s look at an example.

S&P 500 and EMA (200).

As you can see, the index has been constantly in an uptrend in the area since 2010, there are only small drops that can be avoided using the EMA (200), which will reduce the drawdown. The strategy is very easy – we just buy when the index is near the average or below and then keep the instrument in the portfolio while above the average.

There is even a special ETF Replay service, where you can test moving averages on various instruments of the American stock market. For example, here is testing ETF trading on the Dow Jones Index (DIA, SPDR Dow Jones Industrial Average) from 2002 to 2018.

Testing with EMA (200). We buy when the price is higher, exit the trade when the price is below the EMA.

Test results. When using EMA (200), the drawdown is almost three times less (18.3% versus 51.9%), while the profit does not differ significantly from 293.2% versus 333%.

Of course, this technique does not work on all stocks and indices, some move more unpredictably, but there is an analytics and checking the history of quotes for this. For example, it is much more difficult to work with moving averages in the Russian stock market.

An example with the RTS index.

It is easier to profit with the Russian market on a return to average values because the market is quite often in a wide channel, but this is still easier to do than on Forex.

As a result, moving averages are quite effective in stock markets, especially if you specifically choose stable instruments. These can be stocks of large companies, well-known brands, American indices, and more. Using moving averages, you can optimize the profit and reduce the drawdown. It is more profitable than investing blindly.