55 Exponential Moving Average Strategy

The 55 Exponential Moving Average Strategy is a single moving average trading system. The single moving average trading strategies use only one moving average and generate their signals based on either the relation of the price versus the MA or based on the MA itself. While you may think that you can’t do much with only one MA, you’d be surprised to know that there are several different ways that a single moving average can be used as a part of a trading system.

Simple Price Crossover

The simple price crossover setup involves going long when price either crosses or closes above the 55 exponential moving average. Reversely, a short is triggered when price closes or crosses below the 55 EMA. This is a simple, easy to implement trading strategy but it tends to only work during strong market trends. During ranges, the losses can be a lot worse compared to the double or triple MA crossover systems.

The chart above shows the 55 exponential moving average in purple, applied to an hourly EUR/USD chart. We marked each close above or below the 55 EMA with an arrow. This is a simple stop and reverse trading strategy. If we’re long and price closes back below the 55 moving average we exit our long and go short instead. As can be seen in the picture, in the time period covered there were eight trading signals, seven of which turned up to be losers. The one win however was much larger than the losses. Most of the losses happened when price was moving around aimlessly in a range.

Using the 55 EMA as a guide

The second common application is using the moving average as a visual guide only and not taking any trades based exclusively off the MA. This strategy is a lot harder to implement because it requires a great deal of previous trading experience. If you decide to try out this strategy, be prepared to invest a lot of time and effort into it. In the long run, the extra work MAY pay off as ‘’chart reading’’ will usually outperform a simple automatic trading system. There are several ways that you can use a single moving average to interpret what price is doing. Let’s start with identifying ranges. When the 55 EMA starts to go flat, this is a good indication that price is moving in a range. Since moving average are trend following indicators, the best course of action after identifying a flat market is to wait for a brakeout. The chart below shows a range on the EUR/USD 1 Hour chart.

Notice how the 55 EMA starts to go flat not long after prices started consolidating. The Euro traded between a low of 1.35237 and a high of 1.36385 for several days. In this situation, you can set up alerts on both sides of the range that will inform you if price travels outside of the range. On MetaTrader 4 this is easy to do. Just click on the <Alerts> tab located at the bottom of the terminal. Once there, right click in the empty space and choose <Create> from the popup menu. You can now create your own alerts. The options here include alert me when the bid or ask price go above / below a certain figure or a time based alert. In our example, we would use alert me when EUR/USD BID > 1.3630 and alert me when EUR/USD BID < 1.3530. These are not the exact prices levels, but It’s good to have few pips leeway so that you have time to react to any fast moves.

Another option is to just set up stop orders at the extremes of the range. You setup a buy stop order at 1.36396 (0.1 pip above the high + usual 1 pip spread for EUR/USD) and sell stop at 1.35236 (0.1 pip below the lowest low). The advantage of this approach is that you don’t have to babysit your trade and look for a perfect entry, the disadvantage is that this will leave you vulnerable to stop hunting and quick price spikes. The chart below shows the eventual brakeout from the range.

After a few days spent in a range, Europe’s single currency broke the 1.36385 high and started a strong trend that lasted for five days. We finally got our exit when price broke below the 55 EMA on December 12th, The EUR/USD was quoted at 1.3751 at this point.

Combining the different approaches

You can also combine the two different approaches we outlined earlier. How can you do this? Simple, you use the Price Crossover method during trends and you use the Guide approach to filter the ranges. Let me demonstrate what I mean by a chart example.

This chart shows the same time period in the EUR/USD we used for our earlier Simple Price Crossover. Notice how after the 3rd crossover (3rd arrow) the 55 EMA goes completely flat signalling that the market is going into a range. We now setup brakeout points at the high and the low of this channel. Whenever price breaks either the high or the low, we would look to enter a trade. The range is marked with a yellow rectangle on the chart to make it easier to spot. After losing -11 pips, - 10 pips and – 6 pips on the first three trades, we finally got a brakeout after price rallied above the top of the channel. The brakeout sparked a rally that lasted for 3 days. When it was over, the EUR/USD was trading 75 pips higher from where we entered our long. When comparing this system to the Simple Price Crossover, not only did this strategy outperform it terms of profitability, it also generated far fewer trades (four versus seven), resulting in reduced transaction costs and lower time commitment.

Combining the 55 EMA with Bollinger Bands

You can also combine the 55 EMA with the Bollinger Bands technical indicator. You can use the BBands as both a trend following or a mean reversion tool. Let’s explore both of these options. The Bollinger Bands Brakeout technique involves buying above the top (upper) Bollinger and selling below the bottom (lower) Bollinger.

For a long signal, our entry would be at the top of the Bollinger Bands. At the same time, price has to be above the 55 exponential moving average and the 55 EMA had to be in ‘’trend mode’’. We already explained how to filter both trends and ranges with the 55 EMA above. The chart below shows how we combined this approach with the 55 EMA.

The picture shows the same period on the EUR/USD 1 Hour chart. After the 55 EMA goes flat, we don’t take any trades. We marked the top and the bottom of the range and we wait for a brakeout. In addition to breaking the high, price has to also move above the upper BBand. When comparing this combo to the 55 EMA standalone approach, we can see that adding the Bands helped to filter two additional losses. The reason for this is because the Bollinger Bands are a dynamic level of support / resistance they require a strong momentum behind price in order to break above / below them. When price finally broke away from the channel, the EUR/USD was already trading above the Bollinger Bands indicating that the rally upward was supported by good momentum.

Using the 55 EMA also helped improve the simple BB Brakeout. After the 55 EMA flattened, we got several additional Bollinger Bands brakeout signals which we didn’t take because the 55 EMA told us we were trading in a range. Can we take this a step further and use the 55 EMA as market environment indicator?

Combining the 55 EMA with Bollinger Bands, Range Trading Version

The most common way traders use Bollinger Bands is as a mean reversion tool. Buy when prices are low (hitting the lower BBand) and sell when prices are high (hitting the upper BBand). Since we already learned how to identify a ranging market (55 EMA goes flat) can we use this filter to improve on the Bollinger Bands mean reversion strategy?

The chart above shows the same time period in the Euro. This time we’ll use the Bands as mean reversion tool instead. After the 55 EMA goes flat (indicated by the large black arrow) we go into range trading mode. We will short the EUR/USD once it trades above the upper Bollinger and we’ll buy the pair on a break below the lower Band. The red arrows mark all the signals. Four out of the five trades ended up being winners. We used a simple take profit exit, a touch of the middle Bollinger Band (20 SMA). Since this is a trend reversal system, a logical place for your stop is just above / below the most recent market swing high / low point. If prices continue to move above / below the swing point and fail to reverse, this is a good indication that the signal generated is not a true reversal. As we can see on the chart, this was exactly what happened with trade number five. Once the single currency broke above the swing high, a strong multiday rally followed suit. You don’t have to choose between the two combos I outlined above. You can use both. If the 55 EMA indicates a flat market, go into mean reversion mode, sell at the top BBand and buy at the bottom. If the 55 EMA is trending, do the opposite, buy at the top Band and sell when prices move below the lower Bollinger Band.

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