In this article, you will be acquainted with another fairly simple and yet effective trading strategy that combines Moving Average Convergence Divergence (MACD) with the Moving Average.
Moving Average and MACD combo strategy works really well in a trending market condition and has good risk management. Find out more about the strategy below.
Trend trading is a strategy that follows the direction of market momentum. The concept is quite simple; trend traders would buy assets during an uptrend or sell them during a downtrend. The practice, however, can be much more complicated than that.
Joining a trend too late will possibly result in a loss since the trend has already exhausted itself. With Moving Averages and MACD combo strategy, you can learn how to ideally enter and close a trade during a trend.
The Setup
This combo strategy involves the following indicators:
- 50 SMA
- 100 SMA
- MACD (default setup)
The 50 SMA is used as a signal line that triggers the trades, while the 100 SMA gives clarity to the trend. The SMA can be hourly or daily, depending on the charts.
Meanwhile, the MACD confirms that the momentum is in motion. The main idea is to buy or sell when the price crosses the SMA in the trend direction as confirmed by the MACD.
How the Combination Works
The Moving Average lines can identify trend direction, but it sometimes gives false signals. That’s why the MACD is added as confirmators. You can see from the chart below that there is a bearish crossing between the SMA lines. However, the MACD signals a bullish movement as the bars step up from negative to positive area.
Rules for Long Position
- First, take a look at the 50 SMA, 100 SMA, and MACD on the charts. See if the following conditions occur:
- The price moves above 50 SMA and 100 SMA and it trades above the closest SMA by 10 pips or more.
- The MACD is positive within the last five bars. If not, you have to wait for the next signal.
- If the aforementioned conditions are met, apply these steps to enter a long position:
- Set the initial stop loss at the lowest low in the last five bars from the entry.
- Close half the position when the price moves up two times the risk and move the stop loss to breakeven.
- Close the rest of the position when the price moves below the 50 SMA by 10 pips.
Rules for Short Position
- Look at the moving average indicators on the charts and check the following conditions:
- The price moves below both the 50 SMA and 100 SMA and it trades below the closest SMA by 10 pips or more.
- The MACD is negative within the last five bars, if not you have to wait for the next signal.
- Next, follow these steps to enter a short position:
- Set the initial stop loss at the highest high in the last five bars from the entry.
- Close half the position at two times risk and move the stop loss to breakeven.
- Close the rest of the position when the price moves above the 50 SMA by 10 pips. Make sure that it’s not between the 50 SMA and the 100 SMA.
No Strategy Is Perfect
Moving Average and MACD combo strategy works more effectively on trending conditions, so it is not quite effective in range-bound markets. Let’s take an example from the hourly chart below. EUR/GBP is typically a range-bound pair, thus it is difficult for this strategy to work on this currency pair.
On March 7, 2006, the price moved below the 50-hour and 100-hour SMA. The MACD was also negative, so we entered a short position at 10 pips below the closest SMA, which was 0.6840. The stop loss was set at the five-bar high, which was 0.6860. This was a risk of 20 pips, meaning the first target was 0.6800 (0.6840–40 pips). The target, however, was never hit as the EUR/GBP sell-off was short-lived. In fact, the low only reached 0.6839 before the price crossed above the 50-hour SMA. The market eventually reverted back to the upside and hit the stop loss level, generating a 20 pips loss.
Conclusion
The Moving Average and MACD combo strategy can help you trade on trends to maximize your profits. But you have to be aware of its conditions. This strategy should be implemented on pairs that trend well, preferably the major ones. You also need to check the extent of the market trend. The ADX (Average Directional Index) can indicate whether the momentum is strong enough for the trend to continue.
