If you had shorted at the crossover of the moving averages you would have made yourself almost a thousand pips! Of course, not every trade will be a thousand-pip winner, a hundred-pip winner, or even a 10-pip winner. It could be a loser, which means you have to consider things like where to place your stop loss or when to take profits.
Introduction
There are no trading strategies that will generate a profit every single time, but there are some really basic strategies that can produce some pretty good results.
One such strategy makes use of exponential moving averages (EMAs), and more specifically, the 5 and 20-period EMAs.
Exponential moving averages provide you with a good indication of the current trend, and when you get a short-term moving average crossing a longer term moving average, ie the 5 crossing the 20 in this case, it is a good indication that the trend has changed.
So in other words, it gives you an opportunity to enter a position right at the start of a new trend.
How to Improve Your Chances of Success
This is not a foolproof strategy by any means because there will be times when you will get false crossovers that don’t turn out to be the start of a new trend, but there are ways to increase your chances of success.
One of the best ways is to use multiple time frames. For example, you might look for a strong upward price move on the daily and 4-hour time frame, wait for a period of retracement on the 1-hour chart, and then enter a long position when the EMA (5) crosses upwards through the EMA (20) on this same time frame when the longer term trend prevails.
To give you an example, the USD/JPY had a strong price move upwards on the 4-hour and daily chart last month and was starting to trend nicely upwards before it retraced nicely with a downward EMA crossover (5 crossing the 20) on the 1-hour chart. It then crossed upwards once again when the trend resumed, which was a perfect entry point:
Indeed there was another upward EMA crossover the next day which would also have been profitable, but I always like to trade the first crossover whenever possible.
If you wanted to, you could also look for strong price moves on the 15-minute and 1-hour time frames, and then enter a position when you get an EMA crossover on the 5-minute chart, but it’s generally more profitable to use longer time frames if you can because the price moves can be quite small on the smaller time frames, which means that the spreads will really eat into your profits.
The Key to Success
What you are basically trying to do is identify pairs that are in strong trends on two longer time frames, and then enter a position when you get an EMA crossover in the same direction on one of the shorter time frames because this is an example of a high probability trade.
This is a lot more profitable than sticking to a single time frame, and is a strategy that many people, including myself, use to generate profits on a regular basis.
Exit Strategies
With regards to exit strategies, you have many options. One option is to run the position until the EMAs cross back in the other direction, ie when the trend runs to its conclusion, which can sometimes yield huge returns, but another option is to look to make a certain number of pips per trade, and move your stop loss to break-even as soon as it is in profit, which is another good strategy.
Final Thoughts
The point is that there are many ways that you can profit from the EMA crossover strategy, and the great thing is that you only really need to use two simple technical indicators.
You don’t need to stick to the 5 and 20-period settings either because you may find that you get equally good results from using a 10 and 20-period EMA crossover strategy instead.
Similarly, if you take a long-term view, the golden cross (upward crossover) and death cross (downward crossover) of the 50 and 200-day EMAs can be even more profitable if you wait for a pull-back and enter at the right time because the resulting price moves can be thousands of pips.
Moving-average crossover strategies often provide an indication of a reversal in trend.
While traders typically use simple moving average crossovers as a sign of a potential reversal, I’ve found that 3-period and 8-period exponential moving average (EMA) crossovers work quite well. Here’s what to look for with this strategy:
The 3 & 8 Setup
With the 3-period and 8-period EMA crossover strategy, I’m really only looking to enter long positions. I also plot the 20-period SMA with this strategy. Quite simply, I’m looking to enter a long position if the 3-period EMA crosses above the 8-period EMA. If the 3-period and 8-period EMAs cross above the 20-period simple moving average, in my experience it tends to be a higher probability trade.
Now that we’ve got the basics of this simple-to-use strategy, let’s look at an example, using the daily chart on Advanced Micro Devices Inc. (AMD), with the 3-day and 8-day EMAs and the 20-day simple moving average plotted.Source: TradingView
Notice that AMD had some choppy trading prior to the crossover and, based on the moving averages, lacked a clear trend for some time. You wouldn’t want to get caught trading in this area because you’d end up churning, getting in and out of trades multiple times.
Now look at the circled area on the chart. The 3-day EMA clearly broke above the 8-day EMA, and both the EMAs broke above the 20-day simple moving average. That’s a high probability trade on the long side.
Here’s what happened next: Source: TradingView
If the price clearly breaks below one of the moving averages, it would be a good idea to stop out of your position.
For example, AMD traded below its 3-day and 8-day EMA, and closed below those moving averages, as shown below. Consequently, it would have been prudent to get out somewhere in that area.Source: TradingView
The bottom line
The 3-period and 8-period exponential moving average crossover is a variation of the traditional moving average crossover strategy. Watch for this setup on your own to get a better idea of how the strategy works, but keep in mind that no strategy works 100 percent of the time; when there is confirmation, however, the 3- & 8- crossover is a usually a good bet.
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Jeff Williams is the lead trader of PennyPro.com. He is a short-term trader of stocks under $10 a share.