How do I use the moving average to create a forex trading strategy? Recently I was reading about day trading on a blog and found out that A forex trading strategy can be created using moving averages. But they did not mention the strategy exactly just mentioned the Name of Strategy. The thing is I wanna know about that strategy.
The incredible plethora of successful day trading stories across the web are like condoms that come in three sizes: Small, Medium and Liars. Most of these blogs are trying to sell you the dream that if you use some combination of indicators that you will easily print money from day trading. In reality, something like 90% of day traders fail within the first year so your best chance of making a million dollars from day trading is to start with two million dollars.
But since you asked about moving averages, here's some info. MA-s are useful for depicting support & resistance as well as the trend. You identify the trend, you take your position and you HOPE that the trend continues. Moving averages have ZERO predictive ability.
Here's the secret sauce. The success of moving average crossover systems is dependent on selecting the right periodicity. The longer the MA, the less noise and the fewer the number of whipsaws. In return for that benefit, your trade execution will be late in and late out (Lag). If you shorten the MA, you'll have more timely entry and exits but you'll incur a lot more whipsaws. The only way to know which MA works best is hindsight.
To see this statistically, back test any moving average that your heart desires. Or for that matter, any combination of moving averages, particularly the most common one, Gerald Appel's Moving Average Convergence Divergence indicator (MACD). If the underlying cooperates, you'll do nicely. If it doesn't, you'll rack up losses.
Or try this. Optimize the indicator via back testing on the first half of your historical data to determine the ideal periodicity. Now use that ideal MA length on the remaining half of the data. Oops, not likely to do very well. Then try that on another security. Oops, not so good.
Every security has a period where one MA (or more) does quite nicely yet it doesn't on another period of data. Only knowing the future will enable you to trade with MA-s and that's obviously not going to happen.
The ever popular MACD is a combination of 3 moving averages and is therefore, a derivative of price. Once you leave the price domain, funky things happen. In the case of MACD, the indicator can present false signals if you don't understand the math behind the calculation. But that's getting a bit into the weeds.
As mentioned in the comments, a blog touting an undisclosed day trading strategy is a waste of your time.
There are a multitude of MA strategies you could use to trade on different time frames and for different instruments, some may be good some may be not so good, you would have to choose one that suits your trading style and back-test it to see how it performs.
However, two questions I would like to ask you are: Why have you chosen to trade FX? And, why have you chosen to do day trading?
I see many questions and answers on this site with only 2 alternatives, either investing for the long term (decades) or day trading. In reality there are many timeframes in between that can be traded successfully.
With day trading you need to basically be in front of your screen for the entire period you are trading, often making split second decisions. Even if you have a mechanical system giving you signals when to buy or sell, will your emotions override the signals your system provides, since last time a similar signal was provided you made a loss. If you took even a slightly longer timeframe, say being in a position from a couple of days to a couple of weeks, you could make all your entry and exit decisions after market close (more with stocks as FX is open 24hr 6 days per week), not become emotional on making trading decisions and not have to be in front of the screen all day.
A simple strategy to use would be to use price action itself and not any indicators. Take the example trading system below:
A Harami is a Japanese Candle Stick Pattern (its meaning is pregnant - the larger candle on the left is pregnant with the smaller candle on the right), basically the smaller candle body on the right is totally within the larger body on the left.
You can set up a search to provide signals for both long and short positions. The criteria could be:
For Long Positions - Bullish Harami
There are a minimum of three candles in a row where the high and low of the current candle are both lower than the high and low of the preceding candle (the diagram shows 4 such red candles).
The last candle with a lower high and lower low is bearish (red) - its close is below its open.
The next candle is bullish (green) - its close is above the open, and its full body is totally within the full body of the previous bearish candle, that is, the open of the green candle is higher than the close of the previous red candle and the close of the green candle is below the open of the previous red candle.
You then place a stop market buy order to buy on the next open only if the price moves 1c above the high of the green candle and place a stop loss at just below the low of the previous red candle. If price does not open or go above the high of the green candle all day you can cancel the order after market close. That way you don't take a trade if prices keep falling instead of changing direction.
If you order does trade you would generally move your stop loss up as the price moves up. You could either have an automatic trailing stop loss set up or manually move your stop loss up to just below the low of the previous candle.
For a Short Position - Bearish Harami
There are a minimum of three candles in a row where the high and low of the current candle are both higher than the high and low of the preceding candle (the diagram shows 4 such green candles).
The last candle with a higher high and higher low is bullish (green) - its close is above its open.
The next candle is bearish (red) - its close is below the open, and its full body is totally within the full body of the previous bullish candle, that is, the open of the red candle is lower than the close of the previous green candle and the close of the red candle is above the open of the previous green candle.
You then place a stop market sell order to short sell on the next open only if the price moves 1c below the low of the red candle and place a stop loss at just above the high of the previous green candle. If price does not open or go below the low of the red candle all day you can cancel the order after market close. That way you don't take a trade if the price continues upwards instead of changing direction.
If you order does trade you would generally move your stop loss down as the price moves down. You could either have an automatic trailing stop loss set up or manually move your stop loss down to just above the high of the previous candle.
Back-testing the Strategies
You can actually print out a chart for a stock or an instrument for 6 moths or a year and back-test this strategy for both long and short positions.
You can keep tally of how many signals were given during the year, how many of the signals turned into trades, how many of the trades were winners and how many were losers, and what the total profit or loss was for both long positions and for short positions.
Using this system you would generally be in a typical trade anywhere from 1 day to about 2 or 3 weeks. If you get onto a really long trend you could be on it for a longer period.
You don't. The strategy you read on the blog is not a strategy to make money trading FX. It's a strategy used by the blogger to drive traffic to his website in order to sell advertising space or training products.
The truth is that hedge funds and investment banks pay huge amounts of money to employ the best quant analysts, with PhDs in math or economics, to devise trading such algorithms and strategies and use high frequency trading and fast computing to employ it. Even like that you'd be surprised to find out that they still mostly make money by commissions on other people trading, or by betting other people's money for a commission.
More directly related to your question, you can think of any strategy you want, back test it extensively and still lose money because there is no guarantee that the strategy will continue working. In fact this is trivial to find such strategy with a neural network for example. Good luck making money with it.
Also don't forget that while modelling of prices of financial instruments as random walks is helpful for some mathematical analysis, in practice political or economic events can have a huge impact and make you lose money.
Even if I'm wrong and it's still possible to find such strategy, you can be sure that you won't find anyone on the internet talking about it. If they do then the strategy is not valid anymore as you will be front run by others trying to employ it before you.