The 3 EMA crossover strategy is a trend trading strategy that utilizes three EMA indicators with different time periods. How reliable are the signals?
An Exponential Moving Average (EMA) is a type of moving average (MA) that places more weight on the recent price. Besides EMA, the most common type of moving average is the simple moving average (SMA). Unlike the EMA, the SMA places equal weight on the price points. For example, a 20-period SMA is the average closing price of the last 20 periods, while the EMA adjusts the weight of price data according to the most relevant movements, which are the most recent ones.
The EMA formula is:
EMA = (Closing Price – EMAprevious day) x Multiplier + EMA previous day
Multiplier = 2 ÷ (Time Periods + 1)
For the initial EMA calculation, the EMA previous day value is unknown; therefore it is replaced with the Initial SMA, the formula of which is:
Initial SMA = Sum of Closing Prices ÷ Time Period
What is an EMA Crossover?
An EMA crossover occurs when two different EMA lines cross one another. The crossover doesn't predict future trends, but rather shows the ongoing direction of a trend. That being said, the crossover might actually give a signal that a trend could be ending and will soon be replaced by a new trend.
On the USD/JPY chart above, we can see crossovers between the 5 EMA and 20 EMA. Notice how after the first crossover the price starts to move down but reverse to the upside after the second crossover.
Why Use 3 EMAs Together?
The three EMAs can give stronger confirmation than just two EMAs crossover. It can also give a better context to the price action in relation to the three EMA lines displayed on the chart. Three EMAs crossing above the price at the same time is a strong bullish signal, while three EMA crossing below the price at the same time is a strong bearish signal.
These EMAs can also be used to define the best entry and exit levels since the three indicators represent the market trend and price momentum on the chart. A crossover between the short-term EMA and long-term EMA serves as a signal to enter a position. Meanwhile, the medium-term EMA indicates a zone of values for possible mean reversion. This means that when the price strays too far, it will eventually return to the medium-term EMA line.
Since the three EMAs display the direction of trend and momentum, we can create our risk to reward ratio by using stop losses, trailing stops, and profit targets. We can also confirm whether the short-term EMA has the same trend direction as the long-term EMA and whether it has the momentum to continue moving in that direction. For example, if the price is below the 10 EMA but above the 50 EMA, this can be a signal of a trend reversal.
See Also: A Trader’s Guide to EMA Strategy
In this article, we will discuss two strategies that involve 3 EMA crossover.
Revealing the Ultimate 3 EMA Crossover Strategy
The three EMAs involved in this strategy are:
- The short-term 10 EMA, acting as the momentum indicator.
- The medium-term 25 or 30 EMA, defining the zones of value.
- The long-term 50 EMA, signaling the longer-term trend.
The first thing you should remember is that this strategy is best applied to trending markets. After that, you may activate the three EMAs on the chart. In this case, we will use a 10-day, 30-day, and 50-day EMA. Now, see the position and movement of each EMA and compare it with the other EMAs and/or the price action.
- If the price is above all the EMAs, this indicates an uptrend and rising momentum. Contrarily, if the price is below all the EMAs, this indicates a downtrend and falling momentum.
- If the 50 EMA is above the 10 and 30 EMA, this indicates that the market has lost short-term momentum. Subsequently, if the price moves below the 50 EMA, this is a potential signal of reversal from a longer-term uptrend into a downtrend.
- If the 10 EMA crosses above the 30 EMA which is positioned above the 50 EMA, this is a signal for you to enter a long position. If the 10 EMA crosses below the 30 EMA which is positioned below the 50 EMA, this is a signal for you to enter a short position.
- If the 10 EMA crosses above the 30 EMA which lies below the 50 EMA, this signals a longer-term downtrend is potentially reversing into a longer-term uptrend. If the 10 EMA crosses below the 30 EMA which lies above the 50 EMA, this is a possible signal that a longer-term uptrend is reversing into a longer-term downtrend.
See Also: Trading Strategy Using 3 Bar EMA
Now that you get the main ideas of using three EMAs, let's take a look at how to use them in the chart. This strategy can be implemented on any currency pair and any time frame, although we suggest the 15-minute chart or longer.
Rules for Long Position
- After the 10 EMA crosses the 50 EMA from below, place a buy stop order 2-5 pips above the high of the candlestick that has a lower high than the previous candlestick.
- The order will be activated once the next candlestick breaks the high of the previous candlestick. If this doesn't happen, keep adjusting the position based on the new lower high until the high is broken.
- Place a stop loss order 2-5 pips below the low of the entry candlestick. If you find a swing low nearby, place a stop loss order a few pips below it.
Let's see the chart below to better understand the strategy.
Rules for Short Position
- After the 10 EMA crosses the 50 EMA from above, place a sell stop order 2-5 pips below the low of the candlestick that has a higher low than the previous candlestick.
- The order will be activated once the next candlestick breaks the low of the previous candlestick. If this doesn't happen, keep adjusting the position based on the new higher low until the low is broken.
- Place a stop loss order 2-5 pips above the high of the entry candlestick. If you find a swing high nearby, place a stop loss order a few pips above it.
Profit Target and Risk Management
As mentioned above, you can use the swing low and swing high levels like the support and resistance to determine your profit target. Alternatively, you can take profits by using a trailing stop. This way, you can ride out the trend until it loses momentum. For a short position, place your trailing stop above each lower high, and for a long position, place your trailing stop below each higher low. Since trailing stop orders only move in one direction, you will limit your losses in the event of a trend reversal.
Pros and Cons of the 3 EMA Crossover Strategy
The Exponential Moving Average is a popular indicator among trend traders, and this strategy maintains all the benefits you can get from the EMAs. It is uncomplicated and easily applicable even though it uses three such indicators at once. Also, the three EMAs help increase the reliability of this strategy, especially in a trending market.
But this strategy naturally carries with it the typical disadvantages associated with an EMA. The first one is that an EMA is a type of lagging indicator, meaning that the trend has already taken place before the EMA line is formed. Secondly, since it relies heavily on EMAs, this strategy is not for range markets. False signals will appear one after another in that condition, so it is for your own good to avoid entering a trade.
See also: 5 Minute Trading Strategy with EMA
An Important Note
You might still be wondering why we shouldn't open a trade once the 10 EMA crosses the 25 EMA. Instead, we place a pending order (sell stop or buy stop) after a cross between the 10 EMA and 50 EMA. This is because the idea behind this strategy is to trade on a return to the previous trend after a retracement occurs, which happens after the EMA crossover.
In addition, the 50 EMA line acts as the support or resistance when the price is above or below it. Thus, the 10 EMA must cross the 50 EMA before we open trade to ensure that the price doesn't move beyond the 50 EMA line. More importantly, don't try out this strategy in a real account if you're a first-timer. Instead, see how it works in a forex demo account before using it for real.