EMA Strategy (with MACD Confirmation)

Introduction

This strategy features a momentum indicator and two trend indicators: the coloured MACD indicator in combination with two exponential moving averages that will acts as support-resistance tools. This strategy is an alternative way of pulling off a retracement trade using three indicators.

This strategy has been optimized for the 4 hour chart, and should be applied to currency pairs which trend very well with typical price range of an average of 300 pips on the 4 hour chart. Each trade tends to last for a week, so this trade requires some degree of patience.

Indicators
The indicators to be used in this strategy are:

  1. a) 50 EMA, which in the example for this trade is set to gold colour.
  2. b) 110 EMA which is set to a red color for this illustration. Both moving averages are deployed with their default settings.
  3. c) Coloured MACD histogram: The colour change associated with this customized indicator is designed to enable the MACD catch the change in trend and momentum earlier than the conventional MACD.

This strategy gets its advantage from early detection of trend change. If this advantage is lost, then the strategy becomes useless.

The Strategy

The moving averages will be used as support-resistance tools. We want the price action to bounce off the moving averages in the desired direction, as well as for these changes to correspond to the appropriate colour for the MACD histogram, for us to set the trade. Usually the moving averages should be pointing towards the direction in which we want the trade to go.

1) Long Trade

These are the rules for the long trade entry with the strategy:

  1. a) The 50 EMA must have crossed the 110 EMA earlier on so that it is now located above it.
  2. b) The MACD histogram must be blue in colour. Remember, blue is bullish as far as this indicator is concerned.
  3. c) The price action must be seen to be bouncing off the 50EMA line. This must occur only after the first two parameters must have been met.

The setup is demonstrated in the example below:

ema_up

Long Trade Setup Showing Entry Points

The chart above shows a situation where the currency pair is trending to the upside. The trick here is to make sure that all the parameters align properly. The two areas which have been marked as the long trade entry points are the only places on this chart where the indicators aligned themselves properly, and only just. However, the two trades would have been very profitable for the trader had they been taken as described.

2) Short Trade
These are the rules for the long trade entry with the strategy:

  1. a) The 50 EMA must have crossed the 110 EMA earlier on so that it is now located below it.
  2. b) The MACD histogram must be red in colour. Remember, red is bearish as far as this indicator is concerned.
  3. c) The price action must be seen to be resisted at the 50EMA line. This must occur only after the first two parameters must have been met.

The setup is demonstrated in the example below:

 ema_down

Short Trade Setup Showing Entry Points

The chart here is interesting. There is an area where it seems the price will bounce back off the 50EMA line for a short trade, but the MACD is blue and therefore does not confirm the trade. This is a “no trade”. These scenarios occur all the time and only serve to deceive traders into making trades that will eventually end badly.

The other area shows price bouncing off the 50EMA and the MACD was red; this is where the short trade entry should be made.

Stop Loss

The 110EMA is the key landmark for the stop loss. The Stop Loss should either be set at some pips above the 110 EMA (short trade) or below the 110 EMA for long trades. The 110 EMA is a very strong support-resistance tool. If price breaks this line, then it is more than likely that the entire move will break down. You therefore need to set a stop loss at this area to protect your position.

Take Profit

This is left at the trader’s discretion, but must be set according to sound technical guidelines. This could be at a resistance for long trades (or support for short trades), or when the MACD changes colour.

Conclusion

The problem with this strategy is that genuine trade opportunities where all indicators line up as they should are hard to come by. The currency pair must be strongly trending as the strategy is impossible to use on a range-bound currency. It requires a lot of patience. So if you are not the patient type of trader, you are better off using one of the simpler strategies. But if you can be patient to seek the best opportunities and follow it to the logical conclusion, your wait will be rewarded handsomely.

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