Currency trading strategy based on MACD, RSI and SMA

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Reliable and Effective FX Trading Strategy Based on MACD, RSI and SMA.

Experienced traders know that different market conditions require different trading approaches. Sometimes it happens that the technical analysis does not work, especially when some crucial or unexpected event shakes out the fundamental part of the analysis and traders’ sentiment is getting driven by psychological factors like fear or greed. But those examples are quite rare and exclusive hence focusing on most often cases would be correct if we talked about seeking a multi-purpose FX trading strategy applicable for many different market situations. It’s also understood that it has to be based on popular and effective technical indicators which deserved to be widely used amid their performance in different conditions. The number of fake signals coming from those indicators has to be extremely low in order to maintain the highest level of efficiency, therefore, the frequency of entries will be quite low as well. If we took the mixture of requirements described above, then one of the best choices would be the FX trading strategy based on MACD, RSI and SMA.

Dozens of articles were written about those three indicators, there is no reason to focus on them in details. We would just shortly describe their main features which have been discovered during the practical usage in real-time trading. The Moving Average of Convergence and Divergence is a rather complicated technical indicator. It’s rather slow in terms of reaction for every single fluctuation of the price but that’s the biggest advantage. MACD is a trend indicator meaning that it does not show exact entry/exit levels in sideways ranges. At the same time, it shows the momentum, direction of a trend and, which is probably the main advantage, it perfectly shows divergences when the current trend is getting exhausted and chances for a reversal are getting higher. We recommend using default settings for MACD indicator as they proved their efficiency for many assets and timeframes.

The Relative Strength Index is a fast oscillator, the most popular among other similar indicators. It points to overbought/oversold levels of a price, confirms or denies divergence from the MACD slow indicator and RSI signals when the current market conditions are changed in the scope of bullish or bearish sentiment. The RSI’s level of 50% is a kind of litmus test for the current trend, showing whether the tendency is going to continue or would the price action change to the completely opposite direction. The default period of RSI oscillator is 14 bars (days or hours, depending on the timeframe) but we recommend changing it to 13 bars for slow-moving currency pairs and assets (like EUR/USD or GOLD), and to 21 bars for volatile financial instruments (GBP/JPY or USD/ZAR).

The Simple Moving Average is an additional technical tool in this FX trading strategy but it’s extremely helpful in determining exact entry/exit points for trading positions. Most of the technical analysts use round-figure periods for SMA (20-, 50-, 100-bars) but we prefer using numbers from the Fibonacci row (21-, 34-, 89-bars). Anyway, the combination of settings for any trading system depends on several factors like the asset to trade on, money management rules and the general trading strategy which is always an individual choice. FinmaxFX offers the widest range of technical indicators in its advanced charting tool, in-depth technical analysis outlooks and online support. The best approach for traders would be to develop a personal trading strategy based on individual financial goals and targets, the volume of trading account and risk-management rules. FinmaxFX clients get a personal account manager to consult and chose the optimal combination of those factors. The broker’s support team consists of experienced traders, therefore, FinmaxFX clients are able to get the deepest consulting possible when it comes to trading in the Forex market.

Once the combination of technical indicators is chosen, it’s time to move forward to assets and timeframes. It’s a well-known fact that the technical analysis works best for financial instruments with higher trading volume rather than for low-volume and volatile assets. The best choice would be EUR/USD for this trading strategy as it’s the most popular currency pair, it has the highest trading volume (60% of the US dollar’s volume-weighted basket is euro) and it’s technically correct (does not have lots of whipsaws, shadows and fake breakouts). Several other currency pairs can also be chosen without losing the efficiency and reliability of the trading system based on MACD, RSI and SMA. For example, USD/CHF and GBP/USD currency pairs are also applicable among other majors, while gold and oil could be considered among commodities. Timeframes range is quite wide: from 1-hour intraday chart to 1-week long-term period. The only thing we would not recommend is trading on shorter timeframes like 5- or 15-minutes as those charts are full of fake trading signals and the strategy’s efficiency would be lowered because of that. Anyway, it’s always better to test the system before using it in the real trading account. FinmaxFX consultants will help traders choosing the hottest and most profitable asset in the Forex market. Let’s move to practical examples.

The 4-hourly chart below shows an example of how this trading system works. There is an obvious and continuous downtrend on EUR/USD which enters into a phase of uncertainty (green line on below the price). Slow MACD starts pointing to a bullish divergence with its lines showing higher lows, while the price keeps charting lower lows. Moreover, the MACD histogram remains in the positive territory (green bars above the 0 level). That’s the first signal to get ready for a reversal. Next, fast RSI has to be monitored. It comes out of the oversold level and charts the series of higher lows, confirming the bullish divergence seen on MACD earlier. Once we get long whipsaw on the 4-hourly candlestick, we open a long position. The profit has to be taken on the test of SMA89, as we can see from the price action that the uptrend is getting exhausted in that range, which puts our current profit at risk. Therefore, it’s better for grabbing your money and run. The overall profit of 100 pips (four-digit quotes) is rather good for such a slow-moving currency pair as EUR/USD, especially in the light of how fast the price bounced off the oversold levels and went back to long-term moving average.

Another example is based on by-trend confirmation. We do not look for a trend reversal here. Let’s imagine we already took some partial profit from the upside movement, or even we missed the reversal pattern for some reasons. We’re looking for good entry level to join the current trend and we see that the price has breached SMA89 clearly, going well above the average price range. The MACD indicator is rather bullish at that moment, both lines are directed North and the histogram is in the positive territory, pointing to a bullish continuation. The RSI oscillator is far from overbought levels, having plenty of room to go up. What happens with EUR/USD is that the pair bounces back to SMA89 support curve, which used to work as the resistance before. The crucial moment is that the RSI stays above the 50% level on that candlestick’s close and the price failed to break through the SMA89 support. We go long on the next candlestick open and we take profit on the second test of the overbought level by RSI. Another 80 pips on EUR/USD with by-trend bounce application of the same three technical indicators working together.

As a conclusion, it’s worth mentioning that the combination of these three technical indicators is widely used in the technical analysis for the FX market. It has lots of practical applications in different market conditions, it works effectively to confirm or deny the recent trend and it shows entry/exit levels for profitable trading both intraday and long-term. At the same time, reading books and making theoretical conclusions is surely useful but that process does not pay bills nor brings profits, unfortunately. The best option to test any trading strategy is to open a real trading account, even the smallest one, and start making real steps in the fascinating journey of the financial markets. FinmaxFX is ready to help, all you need is just sing up on the website.

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Moving Average Strategies for Forex Trading

A forex trader can create a simple trading strategy to take advantage trading opportunities using just a few moving averages (MAs) or associated indicators. MAs are used primarily as trend indicators and also identify support and resistance levels. The two most common MAs are the simple moving average (SMA), which is the average price over a given number of time periods, and the exponential moving average (EMA), which gives more weight to recent prices. Both of these build the basic structure of the Forex trading strategies below.

Key Takeaways

  • Moving averages are a frequently used technical indicator in forex trading, especially over 10, 50, 100, and 200 day periods.
  • The below strategies aren’t limited to a particular timeframe and could be applied to both day-trading and longer-term strategies.
  • Moving average trading indicators can be used on their own, or as envelopes, ribbons, or convergence-divergence strategies.
  • Moving averages are lagging indicators, which means they don’t predict where price is going, they are only providing data on where price has been.
  • Moving averages, and the associated strategies, tend to work best in strongly trending markets.

Moving Average Trading Strategy

This moving average trading strategy uses the EMA, because this type of average is designed to respond quickly to price changes. Here are the strategy steps.

  • Plot three exponential moving averages—a five-period EMA, a 20-period EMA, and 50-period EMA—on a 15-minute chart.
  • Buy when the five-period EMA crosses from below to above the 20-period EMA, and the price, five, and 20-period EMAs are above the 50 EMA.
  • For a sell trade, sell when the five-period EMA crosses from above to below the 20-period EMA, and both EMAs and the price are below the 50-period EMA.
  • Place the initial stop-loss order below the 20-period EMA (for a buy trade), or alternatively about 10 pips from the entry price.
  • An optional step is to move the stop-loss to break even when the trade is 10 pips profitable.
  • Consider placing a profit target of 20 pips, or alternatively exit when the five-period falls below the 20-period if long, or when the five moves above the 20 when short.

Forex traders often use a short-term MA crossover of a long-term MA as the basis for a trading strategy. Play with different MA lengths or time frames to see which works best for you.

Moving Average Envelopes Trading Strategy

Moving average envelopes are percentage-based envelopes set above and below a moving average. The type of moving average that is set as the basis for the envelopes does not matter, so forex traders can use either a simple, exponential or weighted MA.

Forex traders should test out different percentages, time intervals, and currency pairs to understand how they can best employ an envelope strategy. It is most common to see envelopes over 10- to 100-day periods and using “bands” that have a distance from the moving average of between 1-10% for daily charts.

If day trading, the envelopes will often be much less than 1%. On the one-minute chart below, the MA length is 20 and the envelopes are 0.05%. Settings, especially the percentage, may need to be changed from day to day depending on volatility. Use settings that align the strategy below to the price action of the day.

Ideally, trade only when there is a strong overall directional bias to the price. Then, most traders only trade in that direction. If the price is in an uptrend, consider buying once the price approaches the middle-band (MA) and then starts to rally off of it. In a strong downtrend, considering shorting when the price approaches the middle-band and then starts to drop away from it.

Once a short is taken, place a stop-loss one pip above the recent swing high that just formed. Once a long trade is taken, place a stop-loss one pip below the swing low that just formed. Consider exiting when the price reaches the lower band on a short trade or the upper band on a long trade. Alternatively, set a target that is at least two times the risk. For example, if risking five pips, set a target 10 pips away from the entry.

Moving Average Ribbon Trading Strategy

The moving average ribbon can be used to create a basic forex trading strategy based on a slow transition of trend change. It can be utilized with a trend change in either direction (up or down).

The creation of the moving average ribbon was founded on the belief that more is better when it comes to plotting moving averages on a chart. The ribbon is formed by a series of eight to 15 exponential moving averages (EMAs), varying from very short-term to long-term averages, all plotted on the same chart. The resulting ribbon of averages is intended to provide an indication of both the trend direction and strength of the trend. A steeper angle of the moving averages – and greater separation between them, causing the ribbon to fan out or widen – indicates a strong trend.

Traditional buy or sell signals for the moving average ribbon are the same type of crossover signals used with other moving average strategies. Numerous crossovers are involved, so a trader must choose how many crossovers constitute a good trading signal.

An alternate strategy can be used to provide low-risk trade entries with high-profit potential. The strategy outlined below aims to catch a decisive market breakout in either direction, which often occurs after a market has traded in a tight and narrow range for an extended period of time.

To use this strategy, consider the following steps:

  • Watch for a period when all of (or most of) the moving averages converge closely together when the price flattens out into sideways range. Ideally, the various moving averages are so close together that they form almost one thick line, showing very little separation between the individual moving average lines.
  • Bracket the narrow trading range with a buy order above the high of the range and a sell order below the low of the range. If the buy order is triggered, place an initial stop-loss order below the low of the trading range; if the sell order is triggered, place a stop just above the high of the range.

Moving Average Convergence Divergence Trading Strategy

The moving average convergence divergence (MACD) histogram shows the difference between two exponential moving averages (EMA), a 26-period EMA, and a 12-period EMA. Additionally, a nine-period EMA is plotted as an overlay on the histogram. The histogram shows positive or negative readings in relation to a zero line. While most often used in forex trading as a momentum indicator, the MACD can also be used to indicate market direction and trend.

There are various forex trading strategies that can be created using the MACD indicator. Here is an example.

  • Trade the MACD and signal line crossovers. Using the trend as the context, when the price is trending higher (MACD should be above zero line), buy when the MACD crosses above the signal line from below. In a downtrend (MACD should be below zero line), short sell when the MACD crosses below the signal line.
  • If long, exit when the MACD falls back below the signal line.
  • If short, exit when the MACD rallies back above the signal line.
  • At the outset of the trade, place a stop-loss just below the most recent swing low if going long. When going short, place a stop-loss just above the most recent swing high.

Guppy Multiple Moving Average

The Guppy multiple moving average (GMMA) is composed of two separate sets of exponential moving averages (EMAs). The first set has EMAs for the prior three, five, eight, 10, 12 and 15 trading days. Daryl Guppy, the Australian trader and inventor of the GMMA, believed that this first set highlights the sentiment and direction of short-term traders. A second set is made up of EMAs for the prior 30, 35, 40, 45, 50 and 60 days; if adjustments need to be made to compensate for the nature of a particular currency pair, it is the long-term EMAs that are changed. This second set is supposed to show longer-term investor activity.

If a short-term trend does not appear to be gaining any support from the longer-term averages, it may be a sign the longer-term trend is tiring out. Refer back the ribbon strategy above for a visual image. With the Guppy system, you could make the short-term moving averages all one color, and all the longer-term moving averages another color. Watch the two sets for crossovers, like with the Ribbon. When the shorter averages start to cross below or above the longer-term MAs, the trend could be turning.

Forex: The Moving Average MACD Combo

In theory, trend trading is easy. All you need to do is keep on buying when you see the price rising higher and keep on selling when you see it breaking lower. In practice, however, it is far more difficult to do this successfully. The greatest fear for trend traders is getting into a trend too late, that is, at the point of exhaustion. Yet despite these difficulties, trend trading is probably one of the most popular styles of trading because when a trend develops, whether on a short-term or long-term basis, it can last for hours, days and even months.

Tutorial: Forex Trading Rules

Here we’ll cover a strategy that will help you get in on a trend at the right time with clear entry and exit levels. This strategy is called the moving average MACD combo. (For background reading, see A Primer On The MACD.)

The MACD combo strategy involves using two sets of moving averages (MA) for the setup:

  • 50 simple moving average (SMA) – the signal line that triggers the trades
  • 100 SMA – gives a clear trend signal

The actual time period of the SMA depends on the chart that you use, but this strategy works best on hourly and daily charts. The main premise of the strategy is to buy or sell only when the price crosses the moving averages in the direction of the trend. (To learn more, read the Moving Averages tutorial.)

Rules for a Long Trade

  1. Wait for the currency to trade above both the 50 SMA and 100 SMA.
  2. Once the price has broken above the closest SMA by 10 pips or more, enter long if MACD has crossed to positive within the last five bars, otherwise wait for the next MACD signal.
  3. Set the initial stop at a five-bar low from the entry.
  4. Exit half of the position at two times risk; move the stop to breakeven.
  5. Exit the second half when the price breaks below the 50 SMA by 10 pips.

Rules for a Short Trade
Wait for the currency to trade below both the 50 SMA and 100 SMA.

  1. Once the price has broken below the closest SMA by 10 pips or more, enter short if MACD has crossed to negative within the last five bars; otherwise, wait for the next MACD signal.
  2. Set the initial stop at a five-bar high from entry.
  3. Exit half of the position at two times risk; move the stop to breakeven.
  4. Exit the remaining position when the price breaks back above the 50 SMA by 10 pips. Do not take the trade if the price is simply trading between the 50 SMA and 100 SMA.

Long Trades
Our first example in Figure 1 is for the EUR/USD on an hourly chart. The trade sets up on March 13, 2006, when the price crosses above both the 50-hour SMA and 100-hour SMA. However, we do not enter immediately because MACD crossed to the upside more than five bars ago, and we prefer to wait for the second MACD upside cross to get in. The reason we adhere to this rule is because we do not want to buy when the momentum has already been to the upside for a while and may therefore exhaust itself.

The second trigger occurs a few hours later at 1.1945. We enter the position and place our initial stop at the five-bar low from entry, which is 1.1917. Our first target is two times our risk of 28 pips (1.1945-1.1917), or 56 pips, putting our target at 1.2001. The target gets hit at 11am EST the next day. We then move our stop to breakeven and look to exit the second half of the position when the price trades below the 50-hour SMA by 10 pips. This occurs on March 20, 2006 at 10am EST, at which time the second half of the position is closed at 1.2165 for a total trade profit of 138 pips.

Figure 1: Moving Average MACD Combo, EUR/USD

Source: FXtrek Intellichart

Positive and Negative Oscillations
Why can’t we just trade the MACD cross from positive to negative? You can see by looking at the EUR/USD in Figure 2 that multiple positive and negative oscillations occurred between March 13 and March 15, 2006. However, most of the downside and even some of the upside signals, if taken, would have been stopped out before making any meaningful profits.

Why can’t we just trade the moving average cross without the MACD? Take a look at Figure 2. If we took the moving average crossover signal to the downside when the MACD was positive, the trade would have turned into a loser.

Source: FXtrek Intellichart

The next example, shown in Figure 3, is for USD/JPY on a daily time frame. The trade sets up on September 16, 2005, when the price crosses above both the 50-day and 100-day SMA. We take the signal immediately because the MACD has crossed within five bars, giving us an entry level of approximately 110.95. We place our initial stop at the five-bar low of 108.98 and our first target at two times risk, which comes to 114.89. The price is hit three weeks later on October 13, 2005, at which time we move our stop to breakeven and look to exit the second half of the position when the price trades below the 50-day SMA by 10 pips. This occurs on December 14, 2005, at 117.43, resulting in a total trade profit of 521 pips.

One thing to keep in mind when using daily charts: although the profits can be larger, the risk is also higher. Our stop was close to 200 pips away from our entry. Of course, our profit was 521 pips, which turned out to be more than two times our risk. Furthermore, traders using the daily charts to identify setups need to be far more patient with their trades because the position can remain open for months.

Figure 3: Moving Average MACD Combo, USD/JPY

Source: FXtrek Intellichart

Short Trades
On the short side, we take a look at the AUD/USD on hourly charts back on March 16, 2006. The currency pair first range trades between the 50- and 100-hour SMA. We wait for the price to break below both the 50- and 100-hour moving averages and check to see whether MACD has been negative with the past five bars. We see that it was, so we go short when the price moves 10 pips lower than the closest SMA, which in this case is the 100-hour SMA. Our entry price is 0.7349. We place our initial stop at the highest high of the last five bars or 0.7376. This places our initial risk at 27 pips. Our first target is two times the risk, which comes to 0.7295. The target gets triggered seven hours later, at which time we move our stop on the second half to breakeven and look to exit it when the price trades above the 50-hour SMA by 10 pips. This occurs on March 22, 2006, when the price reaches 0.7193, earning us a total of 105 pips on the trade. This is definitely an attractive return given the fact that we only risked 27 pips on the trade.

Figure 4: Moving Average MACD Combo, AUD/USD

Source: FXtrek Intellichart

From a daily perspective, we take a look at another short example in EUR/JPY shown in Figure 5. As you can see, the daily examples date farther back because once a clear trend has formed, it can last for a long time. If it didn’t, the currency would instead move into a range-bound scenario where the prices would simply fluctuate between the two moving averages.

On April 25, 2005, we saw EUR/JPY break below the 50-day and 100-day SMA. We check to see that the MACD is also negative, confirming that momentum has moved to the downside. We enter into a short position at 10 pips below the closest moving average (100-day SMA) or 137.76. The initial stop is placed at the highest high of the past five bars, which is 140.47. This means that we are risking 271 pips. Our first target is two times risk (542 pips) or 132.34. The first target is hit a little more than a month later on June 2, 2005. At this time, we move our stop on the remaining half to breakeven and look to exit it when the price trades above the 50-day SMA by 10 pips. The moving average is breached to the top side on June 30, 2005, and we exit at 134.21. We exit the rest of the position at that time for a total trade profit of 448 pips.

Figure 5: Moving Average MACD Combo, EUR/JPY

Source: FXtrek Intellichart

When the Strategy Fails
This strategy is far from foolproof. As with many trend-trading strategies, it works best on currencies or time frames that trend well. Therefore, it is difficult to implement this strategy on currencies that are typically range bound, like EUR/GBP.

Figure 6 shows an example of the strategy’s failure. The price breaks below the 50- and 100-hour SMA in EUR/GBP on March 7, 2006, by 10 pips. The MACD is negative at the time, so we go short 10 pips below the moving average at 0.6840. The stop is placed at the highest high of the past five bars, which is 0.6860. This makes our risk 20 pips, which means that our first take-profit level is two times the risk, or 0.6800.

EUR/GBP continues to sell off, but not strongly enough to reach our take-profit level. The low in the move before the currency pair eventually reverses back above the 50-hour SMA is 0.6839. The reversal eventually extends to our stop of 0.6860 and we end up losing 20 pips on the trade.

Figure 6: Moving Average MACD Combo, EUR/GBP

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