Last updated on October 17th, 2020
Your trading strategy does not have to be complex.
In fact, when you have too many moving parts in a strategy, it’s difficult to make adjustments or even just test it.
If we break down what we are looking for in a strategy, it is simply: the probability of one thing happening over another.
This 34 EMA trading strategy not only uses an exponential moving average, but also includes trend lines.
What’s The Deal With Trendlines?
Trendlines are a good tool to find the rhythm of the market. When price action begins to break from through the trendlines, we are seeing a change in the rhythm and balance of power shift.
This is not a complete trendline tutorial. For a more indepth review of drawing trendlines, you can review the article: Define Your Trend Line Drawing Rules
On the left, we have a downwards trendline that connects the peaks of price. This is the longer term line and indicates the prevailing trend long term.
The red line connects the final swing into the low. For my rules, I have be able to connect the last swing into lows/highs. This line will break before the long term and that just puts me on alert of a potential change in market state.
- Break above red line is tentative longs
- Break below is tentative shorts
- Break above/below long term line is a change of trend to be confirmed with price action
That’s is all you really need to know about trendlines in the context we are going to use them.
34 EMA – Just A Number
I don’t want you going down the moving average rabbit hole looking for best settings for the moving average. This is just a medium length moving average and one that I have used in the CCI trading strategy.
You can see the slope showing downtrend, uptrend, and a flat moving average that will either show a market in trend transition or a trading range.
Price breaks above and below the moving average several times and that is not a way you’d want to trade it. However, often times traders will use a close above/below a trend line for trend direction.
Combining the 34 EMA + Trendlines For A Trading Strategy
Since we see that trend lines show a rhythm to the market, and when that rhythm finally breaks, we can combine it with the moving average for trend direction and entry trigger.
Here is the same chart with both the trendlines and the 34 exponential moving average.
Let’s break down the trading strategy:
- Apply an exponential moving average to your chart and set the lookback periods to 34
- Draw relevant trend lines ensuring you have a longer term line and a short term line
- We are looking to see a break of both the rhythm of the market and the trend direction
Once you have the trend lines and the EMA on your price chart:
- Look to see an early warning of a setup with a break of the shorter term trend line
- Price breaks above (for a long) both the moving average and the longer term trend line
- It does not matter which one is first
Looking at the chart above, we see on the left that price did break the moving average and close above it.
This is not a long setup.
We need both the average and the trendline to be violated on close.
As we move to the middle of the chart, we find our setup and trigger rules in effect:
- Price breaks the short term trend line to the upside putting us on alert for a potential long setup
- Price breaks both the moving average and the trend line to the upside. Price closes above both
Traders can enter on close or buy stop the high of the trigger candlestick.
Not The Holy Grail
Every single trading strategy will lead to losers as well as missing big moves. This is something a trader must come to terms with before ever risking money in the market.
A great example is this futures contract of SUGAR – one hour chart.
Sorry for all the lines but they are needed to give you the proper perspective.
The green circle is a break of the 34 EMA and closing above the shorter term downtrend line. The longer term line was broken long after price crossed the 34 EMA.
On this chart, you will learn a way to take profits as well as setups to avoid.
- After a 5% run up in price, we get a break of the trend line and moving average on a closing basis. This is a great place to exit the trade as A. we’ve put in a lower low B. Price has broken our setup criteria. Why is this not an entry? A rule of thumb for traders is to wait for a pullback after a momentum move in price. While you may miss moves, it does prevent you being in a position that “snaps back”.
- We were unable to draw a down trend line at #1 on this time frame using my rules. I would have been unable to participate in this move.
- Another momentum move breakdown and a setup to avoid
- While you can’t see on this chart, price actually did close below the 34 EMA. Price again rises with momentum and a long trade we would skip
This is a good lesson that your chosen time frame can make a different whether you participate in the market or not.
Your Trading Plan For 34 EMA/Trendline Strategy
Now it’s time for you to do some work.
First order of business is to focus on the risk component of these trading setups. There are several ways to set up your initial stop loss:
- Use an average true range stop
- Look for a swing high or low to place your stop
- Use the low or high of the candlestick the was the setup
You have to decide what you are comfortable with.
You can see the difference using a swing level and the ATR stop location. Either one would not have been tested in this particular trade.
We have to know when to take our profits and like the stop loss, it depends on the trader:
- Breaks of swing points on the chart
- Break of the trend line or moving average
- A multiple of your risk or a trailing stop loss
Either of these is a viable way of taking profits.
- This is the break of a swing level and as you follow the red line, you can see the exit
- Break of longer term trend line in this example
- Break of a trailing stop using the 34 EMA
- Break and close under the EMA
I made sure to choose an example that wasn’t perfect as it’s too easy to find where everything is working out with big profits.
Other things to note:
- Will you discount using momentum style candles or will you consider them showing a solid shift in direction?
- How many positions will you carry?
- Will you use a re-entry technique or pyramid your positions?
There is no wrong or right answer for these.
If you are considering additional trades, a simple technique is as follows:
We are simply playing trend line breaks in the direction of the 34 EMA. One important factor to consider is whether you will use these shorter term trend lines as part of the setup for the main part of the strategy.
There will be times where a break of the shorter term trend line occurs with the EMA and then would rally and give you an entry in the other direction.
As you see here, the longer term trend direction is down. The red line is used for the shorter term and so I can use the swing high into the low.
You can see by the green circle, this is an actual legitimate setup. Price quickly reverses short again causing a quick stop out.
Trades will lose and there is no way to prevent that.
But if you can miss some losing trades so you can get setup for a with longer term trend trade, why not do so?
This trading strategy uses two popular methods of technical analysis: moving averages and trend lines.
You can take advantage of the main trend change when both are broken with a close in either direction
Traders will have to decide if they will take additional setups and to do so, will have to adjust their criteria for a setup.
If you have knowledge of support and resistance and other price action methods, you may find them to be useful in this strategy. As an example, look back to the chart of SUGAR when a lower low was put in. This can often lead to a trend change but at the least, shows that there was weakness.
That may change your approach in trading during that time period.