Our strategy is comprised of two elements. The first degree to capture a new trend is to use two exponential moving averages as an entry filter.
By using one moving average with a longer period and one with a shorter period, we automate the strategy. This removes any form of subjectivity from our trading process.
Step #1: Plot on your chart the 20 and 50
The first step is to properly set up our charts with the right moving averages. We can identify the crossover at the later stage. The strategy uses the 20 and 50 periods .
Most standard trading platforms come with default moving average indicators. It should not be a problem to locate the either on your MT4 platform or Tradingview.
Step #2: Wait for the crossover and for the price to trade below the 20 and 50 .
The second rule of this moving average strategy is the need for the price to trade below both 20 and 50 . Secondly, we need to wait for the crossover (20 below 50 ), which will add weight to the case.
By looking at the crossover, we create an automatic buy or sell signals.
Since the market is prone to false breakouts, we need more evidence than a simple crossover. At this stage, we don’t know if the sentiment is strong enough to push the price further after we sell to make a profit.
To avoid the false breakout, we added a new confluence to support our view. This brings us to the next step of the strategy.
We refer to the crossover for a sell trade when the 20-EMA crosses below the 50-EMA .
Step #3: Wait for the zone between 20 and 50 to be tested at least twice, then look for selling opportunities.
The conviction behind this moving average strategy relies on multiple factors. After the crossover happened, we need to exercise more patience. We will wait for two successive and successful retests of the zone between the 20 and 50 .
The two successful retests of the zone between 20 and 50 give the market enough time to develop a trend.
Never forget that no price is too high to buy in trading. And no price is too low to sell.
Note* When we refer to the “zone between 20 and 50EMA,” we actually don’t mean that the price needs to trade in the space between the two moving averages.
We just wanted to cover the whole price spectrum between the two EMAs. This is because the price will only briefly touch the shorter moving average (20-EMA). But this is still a successful retest.
Now, we still need to define where exactly we are going to sell. This brings us to the next step of the strategy.
Step #4: Sell at the market or a limit order when we retest the zone between 20 and 50 for the third time.
If the price successfully retests the zone between 20 and 50 for the third time, we go ahead and sell at the market price inside the zone with a candle close or limit order at 50 line. We now have enough evidence that the momentum is strong to continue pushing this market lower.
Now, we still need to define where to place our protective stop loss and where to take profits. This brings us to the next step of the strategy.
Step #5: Place the protective Stop Loss 20 pips above the 50
After the crossover happened, and after we had two successive retests, we know the trend is down. As long as we trade below both exponential moving averages the trend remains intact.
In this regard, we place our protective stop loss 20 pips above the 50 . We added a buffer of 20 pips because we understand we’re not living in a perfect world. The market is prone to do false breakouts.
Step #6: Take Profit once we break and close above the 50-EMA
In this particular case, we don’t use the same exit technique as our entry technique, which was based on the crossover.
If we waited for the crossover to happen on the other side, we would have given back some of the potential profits. We need to consider the fact that the exponential moving averages are a lagging indicator.
The formula used to plot our EMAs allow us to still take profits right at the time the market is about to reverse.