Many traders like to use moving average to trade because of its simplicity and ease of use. But what if we use 3 EMA lines at the same time? Does it stay true for easy trading?
Exponential Moving Average (EMA) is one of the most popular technical indicators used by forex traders worldwide. Just like any other type of moving averages, EMA is a lagging indicator, which means that it relies on past prices to predict the direction of future prices.
Despite its lagging nature, EMA can help traders read the market condition and build the basis of their trading strategy. So instead of buying and selling anywhere on the chart, the moving average will guide traders to focus on a particular position to trade. Afterward, traders can practice using simple price action patterns to decide on the trading execution.
In this article, we will particularly discuss a moving average crossover strategy that will use three different exponential moving averages with different periods to identify signals on the chart. Although the strategy is peculiar for scalping, it is not limited to that trading method and suitable for both beginners and professionals.
Why Using 3 Moving Averages for a Strategy?
The first thing to note is that just like any other trading strategy, the 3 EMA scalping strategy is not a magical path that can lead you to success every single time. It has some drawbacks, but it is simple enough to learn even for novice traders and can be quite effective if used in the correct way.
By using three moving averages at once, you will be able to see the current direction of price on the chart as well as determine stop losses, trailing stops, and profit targets for further safety.
The main benefit of using this strategy is that it can show whether the shorter-term trend is going in a favorable direction. The shorter-term trend can confirm the longer-term moving average and show a divergence. From the shorter trend, we can also determine if we will be taking a trade that follows the trend or counter it.
The biggest difference if you use two or three moving averages is that the strategy with three moving averages will have a longer-term trend direction. However, keep in mind that because of the lagging disposition of moving averages, the indicator won't be able to pick tops and bottoms quite accurately. Sometimes, much of the price movement has occurred before you enter the trade. Therefore, if the price moves a lot during the gap time, you can get stopped out. Another thing to note is that in ranging markets, the 3 EMA scalping strategy won't perform well because it can give you many false trading signals.
Understanding the Three Moving Averages
In this strategy, you will need the three following exponential moving averages:
- 9-period EMA, which acts as the shorter-term trend indicator. If the 9 EMA line crosses over the 21 EMA line but still above the 55 EMA, that means it is an uptrend and a good long opportunity. Meanwhile, if it crosses below 21 EMA and 55 EMA, then it is a downtrend and a good short opportunity.
- 21-period EMA is considered the medium-term trend indicator, so what we would want to see is when the 21 line is below the 9 and above the 55 for an uptrend. In comparison, the 21 EMA line should be above both the 9 and 55 lines to confirm a downtrend.
- 55 period-EMA, which represents the longer-term trend direction. If the 55 EMA is below both the 9 and 21 EMAs, the trend is going upwards. In contrast, if the indicator is above both of the shorter-term moving averages, then we can see that the trend is going downward.
Before we set up our charts, we should check the market condition by looking at the state of the moving averages. There are at least 4 key principles that we must remember:
- If the indicators are all tangled together, that means the market is in a trading range.
- If the 9 and 21 EMAs are crossing and then separating, that means it is a trending market.
- If the faster moving average starts to pull away from the others, then there is a momentum to enter the market.
- If all of the indicators are lining up, then there is a strong trend going on.
Now that we examined the market condition, we can determine what type of trading setups that we need to enter the market.
See Also: 5 Minute Trading Strategy with EMA
How to Use 3 EMA Scalping Strategy
Rules for Buy Position
- Look for the line up of 3 EMA lines in the same direction.
- Wait until the 9 EMA crosses above 55 EMA and both 9 and 21 are above 55.
- Place a buy order on the next candle after the crossover.
- Pay attention to the swing high on the left side; we should only buy from the close of the candlestick that takes out the previous swing high.
Rules for Sell Position
- In this setup, we would be paying attention to the lowest swing low of the range because it needs to be broken to consider opening a short position.
- Make sure that the 9 EMA has crossed below the 55 EMA and both 9 and 21 EMAs are below the 55 EMA.
- Sell the close of the candlestick following the moving average crossover.
- Watch for the swing low on the left side; we should only sell from the close of the candlestick that takes out the previous swing low.
Where to Place the Exit Position
Essentially, there are many ways of placing your stop loss in this type of strategy. What needs to be considered is that you must allow room for the price to move, so don't place it exactly on the line but also don't put it too far away either.
The second important thing is to be consistent with your stop losses. In a buy trade, you can place your stop loss at least 2-5 pips below the low of the candlestick that has its high broken. You can also place your stop loss a few pips outside of the support level if there is one nearby. As for the sell trade, you can place your stop loss at least 5 pips above the high of the entry candlestick.
Now when it comes to take profit, you can use previous swing low or high as your profit targets. Another option is not to place a fixed profit target but use a trailing stop behind each lower swing highs or lows when the price moves in your favor. This way, you can ride on the trend a.k.a getting maximum profits until you get stopped out. Trailing stops will also enable you to lock in profits in case of sudden reversal that may take out your profits immediately.
Here are how the stop loss scenarios for a buy trade can unfold:
Meanwhile, the stop loss placements for a sell position are as follows:
Final Thoughts on the 3 EMA Scalping Strategy
There are many ways that you can choose to make use of moving averages. By using three moving averages in your trading strategy, you will be able to see the longer-term price direction and see the market trends. It is unfortunate that the lagging nature of moving averages may cause problems as the price moves too fast, so it is possible that the moment we enter the market, the price already moves back to its average position. Luckily, to overcome this issue, we can use the momentum based on the separation of the indicators as well as the distance price from the average.
Once we spot a breakthrough of swing levels on the chart, we can be sure that price action is showing us a trending price pattern. Having three moving averages at once like in the 3 EMA scalping strategy will make your judgment even stronger and more accurate. Remember that if the indicators are separating in the averages, we have a trend. In contrast, if the price is whipping back and forth around the averages, we have a range trend. All in all, use the indicators wisely and make sure to make decisions based on logical reasons. If you're new to this strategy, make sure to try it on a demo account first before applying the strategy in a real account.