SMA Crossover Strategy
In this article, we will cover the SMA Crossover Strategy (also read EMA Crossover Strategy) which uses simple moving averages for a better timing of your entries. Even though a moving average is a lagging indicator, they are not going to tell you what is going to happen in the future, it’s still a useful indicator if you are using more than just a moving average. A very simple strategy if you want to find out whether your currency pair is bullish or bearish or at least which direction you think the price might be moving is to use a crossover strategy. A moving average crossover strategy needs at least two moving averages in order for a crossover to happen. This SMA crossover strategy uses the 5 SMA in combination with the 20 SMA.
This strategy may sound simple, but actually it does help crystallize whether you should be short or whether you should be long a currency pair. This is a very simplified strategy that over time it can help all of us position ourselves correctly in the market. This strategy can be useful to all types of traders no matter of how long your time frame horizon may be.
The main advantage of using any SMA crossover strategy is that it helps you to catch the trend while the biggest disadvantage is that when we’re trading in a range it’s notorious for making multiple crossovers and thus giving many false signals. However, with this strategy you’ll learn how to profit even when the market is ranging. There is a simple and effective way to interpret the price action during that type of environment, but first we’re going to focus on the basics.
When the 5 SMA (the fast moving average) crosses below the 20 SMA (the slow moving average) from above, we have a sell signal while when the 5 SMA crosses above the 20 SMA we have a buy signal. Basically, when the crossover happens the market tells you that there is a shift in momentum and signals the possibility of a trend reversal.
Sometime you’re going to notice that the crossover doesn’t take very smoothly so you’re going to find many instances when the crossover happens in both directions of the market multiple times in a very short period of time and usually this is indicative of a ranging market.
Whenever these confusing crossover signals appear is to find the lowest and highest points within the range and within the period of time where the crossover happens multiple times. In this particular example (see figure below) we have drawn a black dotted line below the lowest point (see green arrow) so the next time the market’s moving averages crosses below that level, so when you see a new low made by the moving averages that tell you that the market is favoring the downside and you go short. At the same time, this can happen on the flip side as well and you apply the same rules.
The benefits of using this SMA crossover strategy is that no matter if the market is trading or ranging you can apply this simple rules to take advantage of both of the two trading environments. Taking in consideration that the market spends most of the time in a range this strategy can be handy in spotting a breakout of the range.
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