More Trading Rules - Building a System (part 2)Last week we started by establishing our first rule which stated that our moving averages (MA's) were all moving together in the same direction. Adding a SignalThis week we'll add a second MA which will give us some additional criteria that should be met before we enter a trade.Let's add another exponential MA to our chart and set it for 40 periods. Now that we have two trend lines, we can establish a couple of more rules. We can now add a rule that says we will only enter a trade on the "long" (buy) side if the shorter MA is above the longer MA. If you look at the image below you can see the shorter MA (red line) starts out below the longer MA (blue line) and then crosses to be above it. Our new rule says that we can now enter a trade in the long (buy) direction. We can also use this relation to exit trades. If we were "short" this currency pair and the MA's crossed up as the image shows, we can use this as the exit signal for our trade.
As with most trading "signals", the longer period charts will tend to be more reliable. If you are following a 1 minute chart, the lines will cross so often that you will have a tough time making any profits. By the same logic, it will also be a challenge to profit short-term if you use the cross on a weekly chart as your signal, because most of us lack the funding to be able to ride the daily price swings that are common. There is always a trade-off between responsiveness and reliability when choosing a time period to monitor. You will need to experiment to determine which period will work best as a part of your system. Try starting out using the MA cross on a 30 minute or hourly chart as one of your signals. They are likely to best suit most newer short-term traders. As you gain experience, adjust the time frame to monitor the period that best suits your own style of trading. In time, you will learn to "read" the strength of the trend by observing how the two MA lines react with each other. Diverging lines show increasing strength while converging lines indicate the trend may be running out of steam. Next week we'll start exploring some of the other indicators available to add to our system and establish some additional trading rules. Wishing you trading success,
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