Day trading using moving averages (part 5)

The final part of this series about day trading using moving averages shows a simple but an apparently effective day trading strategy for forex trading. This strategy uses two different moving averages. A weighted moving average (WMA) serves as trend indicator and a simple moving average (SMA) serves as the trigger for trading signals. The strategy has a fixed target of 20 pips and a stop loss of 15 pips.

WHEN THE SMA AND THE WMA CROSS

A weighted moving average is a variation of the simple moving average. When calculating a SMA, every traded price has the same weight. When calculating a WMA, the more recent the price the more relevant it is, thus the more weight it is given. The WMA is set to 144 periods and the SMA to 5 periods. When the SMA crosses the WMA upwards it is considered a bullish event and the strategy buys a long position. When the SMA crosses the WMA downwards it is considered a bearish event and the strategy opens a short sell position. 

EUR/USD, 10-minute chart

We tested the strategy on the major forex pair EUR/USD using a 10-minute time frame. The profit target is a modest 20 pips which should be hit fairly quickly. This example shows a long trade and a short sell trade. A long position is bought at around 04h30 (green arrow). The target is reached at 06h00 (green zone). When the SMA crosses back below the WMA at 10h20, a short sell position is opened (red arrow). The position reaches its target about one hour later (red zone).

QUICK STRATEGY TEST

Of course not every trade will run as smoothly as these two examples. To test, we ran this strategy over a random period of 14 days. A total of 21 trading signals were detected. Of these 21 signals, 11 resulted in a profitable trade and 10 in a losing trade.

The majority of the signals resulting in a losing trade occurred outside the main trading hours of the market. An improvement could be to add a block filter. The block filter rejects all signals which occur during a specified period of time, in this case outside the main trading hours.

Different settings for the SMA did not yield better results. As soon as the span parameter is increased to 20 or 30 periods, trade results worsen. The strategy appears to prefer short time frames.

CONCLUSION

The main benefit of this trading strategy based on moving averages is its simplicity. A trend filter in a higher time frame as well as a block filter could be added.