Twin EMA Strategy For Effective Trend Trading
There are many ways to trade forex profitably. Some strategies and philosophies are complicated while others tend to be more simple in approach. The following strategy uses simple concepts to provide structure for choosing quality set ups. It requires a combination of analysis, candlestick patterns, and dual Exponential Moving Averages (EMA). These tools are used to locate swing highs/lows at appropriate times in a trend to ride it to profit.
- Common, consistent trading methodology that is tried and true.
- Works well on any chart pair.
- Can be used on almost any time frame. Lower time frames require greater discretion on the part of the trader.
- Not for use as a range-bound market strategy.
- Long-term pair inconsistency can result in less trading opportunities for the trader who tries to stick to one or two pairs. The trader can remedy this problem by looking for opportunities on a lower time frame chart.
*Exponential Moving Averages (10 period and 21 period)
The Exponential Moving Average is a commonly used indicator by many, many traders in a wide variety of strategies. Its primary function is to provide a clear view of the way price has been moving. The "period" setting for the EMA tells the indicator how many time frame periods to look at and average to plot the line on the chart. The trader can opt to set their EMAs to look at different information for the line; but the only one we are interested in is "Closed" which is likely to be the default when setting up an EMA in your trading client.
There are several different types of moving averages but the only one we use is the Exponential. Why? The EMA puts more weight on recent candlesticks to help reflect any present trend and current market action. Historic data is important but we are really concerned with getting a very clear picture of what is going on in the present. That makes the EMA the best choice for this strategy.
A number of candlestick patterns exist that can help a trader pick out important market information. This strategy is most concerned with the Pin Bar and Engulfing Bar patterns. These patterns are the two strongest, most commonly traded reversals signals. Many people try to use candlestick patterns to trade with but they do not realize that they need additional information to ensure they are entering into a high probability trade.
It's not hard to find multiple examples of these two patterns littered all over the charts. Only a fraction of those patterns are worthy of trading. They need to appear in the right locations on the chart. The EMAs and some chart knowledge are going to help you identify whether or not these patterns are printed in the right location.
Stop Loss And Take Profit
The Stop Loss placement for this strategy is similar to other candlestick pattern using strategies. The initial Stop goes just behind the pattern that you're entering on. There are a couple different ways you can manage the Stop with this strategy. You can embrace a "Fire and Forget" methodology where you place the trade, put a Take Profit at 2:1, and just let it go until it hits either stop. Alternatively, you can choose to advance the Stop Loss to secure profit and ride the trend for as long as possible. It completely depends on your preferences as a trader.
A trader can opt for the targeted approach of going for a consistent 2:1 reward to risk as already mentioned or you can wait until market circumstances determine when it's time to exit. Possible exits could include periods of consolidation, advancing the Stop Loss until price moves back and takes you out, or long-term Support and Resistance targets. There's no wrong answer so long as you are securing more than you are risking on your successful trades. Aiming for less than 2:1 means you're going to spend more time recouping losses.
Applying the Strategy
Trend trading strategies need a trend to provide profitability. The EMAs and chart interpretation are going to provide the insight needed for those decisions. The basic rules of a trend apply. An uptrend needs to print higher highs and higher lows; a downtrend needs to print lower lows and lower highs. The candlestick peaks will demonstrate the levels while the EMAs will provide a clear visual indicator to assist your decision making.
The 10 EMA is the more reactionary of the two. It is the EMA that will provide more immediate insight into the present market movement. The 21 EMA is more of a back bone. It is a simple, visual indicator of a larger segment of candlesticks that can help you determine relative strength. The space between the two EMAs is what is most important. The wider the space, the stronger the trend because the 10 will be trying to pull further away from the 21 as the trend continues.
This gap can be used as a support or resistance level of sorts. If price is in a trend, pulls back, and prints a reversal signal in this area; it is showing that the price is trying to bounce off of the average area. On the other hand, price may drop through both EMAs and close below. That is usually not great news for the present trend. The trend could continue but chances are good that it may have lost steam and the pair is ready to consolidate or reverse.
So let's look at some entry and exit rules.
1. 10 and 21 EMA are clearly apart in a pair meeting the conditions for a trend. A clear reversal candlestick pattern prints in or near the 10/21 in favor of the current trend.
2. Jump to the next highest time frame. The present candlesticks should be in favor of your trade. You don't want to enter on a Bullish reversal when the last candlestick on the next higher chart is Bearish.
3. Check for significant areas of Support and Resistance. Ensure you will clear at least 2:1 reward to risk before hitting any major areas of Support and Resistance.
4. If all circumstances are favorable, execute! If even one is not; stay out until a better situation presents itself. It's far easier to lose money in forex than make it. You must develop patience to wait for the optimal setups.
- Any additional reading will quickly reveal advice on how to handle when the 10 and 21 EMAs cross. It means that there is either consolidation or a new trend developing. Since this is a trend trading strategy, you should be waiting for a confirmed trend to try and trade it. A cross of the EMAs only means that price is weak. It tells you nothing more than that. If the EMAs pull apart and price starts setting new high-highs/high-lows or low-lows/low-highs; then look for a trading opportunity. Until then, you're really just guessing.
- The values of the EMAs are not ironclad. If you want to use 7/20 or 12/30 EMAs; you can. Some people use even more than that to see how strong the trend is. A trader running 10/21/50/100/200 EMAs is going to get a very wide range of information over a much longer period of time. With this strategy, you really don't need more than the two. They provide plenty of information with the other supporting factors that are used.
Suggested Additional Reading
This post was written by Daniel Lindsay. You can follow him on Google +. Daniel’s other blog posts on MahiFX can be found here.
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