3 Exponential Moving Average Trading Strategy

The three exponential moving average crossover strategy is an approach to trading that uses 3 exponential moving averages of various lengths.

All moving averages are lagging technical indicators however when used correctly, can help frame the market for a trader. You can see how MA’s can give you information about market states by looking at the Alligator trading strategy that I posted a while ago.

Using moving averages, instead of buying and selling at any location on the chart, can have traders zoning in on a particular chart location.

From there, traders can use various simple price action patterns to decide on a trading opportunity.

 

Why 3 EMA For A Strategy?

There is no magic in moving averages but they can be used to form the basis of a simple trading strategy that works.

You can develop many trading systems using moving averages but remember that complex trading strategies are not always best.

Both day traders and swing traders can benefit from a moving average.

The benefits of using a triple exponential moving average trading strategy?

  1. Shows us the longer term trend direction and if the shorter term trend is in our favor
  2. We can see a shorter term trend to determine if we will be taking a with trend or counter trend trade

You must keep in mind that the lagging nature of moving averages, even EMA’s, will not enable picking tops and bottoms. That is not a bad thing as times when the trend is changing can make for some sloppy trading conditions.

The main difference between using 2 moving averages, such as the Golden Cross strategy, and 3 averages is having a longer term trend direction.

 

The Triple Moving Averages – What Do They Represent?

As I mentioned, the 3 EMA’s will have a different lookback period and they will be:

  • 9 period exponential moving average
  • 21 period exponential moving average
  • 55 period exponential moving average (some will use the 50 EMA moving average but it doesn’t really matter)

The 55 period long term moving average will be considered the longer term trend direction indicator:

  • When the 55 EMA is below both the 9 and 21, we will consider the trend to be up
  • When the indicator is above both of the shorter term moving averages, we will consider the longer term trend to be down

The 21 period exponential moving average is considered a medium term trend indicator:

  • We want to see the 21 below the 9 and above the 55 for an uptrend
  • The 21 should be above the 9 and below the 55 for a down trend

The 9 period short term moving average will be seen crossing over and under the 21 period more times than crossing the 55:

  • The 9 EMA crossing over the 21 while already above the 55, is an uptrend and looking for a buy trade
  • If it crosses below the 21 while already below the 55, that is a down trend and looking for a sell trade

There will be many times where the 9 EMA will crossover the 21 period moving average which will turn the short term trend against the longer term trend. There can be trading opportunities in line with the shorter term trend and against the longer term trend direction.

When we get an mix of trend directions, we are conservative with profit targets and must exit when facing adverse price action.

 

Trading Strategy With Three Moving Averages

While we could simply trade an EMA cross, that is not the best way of using the 3 EMA’s.

Expect a lot of whipsaw if you decide to take a trade based on only a crossover of any moving averages.

You can tell a lot about the market from the state of the moving averages:

  • When the indicators are jumbled together, consider the market to be in a trading range
  • When the faster moving average starts to pull away from the others, consider momentum entering the market
  • Seeing the 9 and 21 EMA crossing and separating, we are looking at a trending market
  • When all the averages line up, strong trend is in play

From those four items, we can determine what type of trading setups we need to enter the market.  We will also consider using support and resistance to help us determine a trade setup.

Trading Rules – Buy Trade

This is a daily stock chart with two different setups.

buy setup and trigger EMA

  1. The 9 EMA has crossed to the upside and the noted arrow closes above the last swing high.  This is a short term resistance level that is broken
  2. Price has pulled back and the 9 EMA crosses to the upside.  Traders would have to wait until there is a close above the last swing high

Using price action, market structure, and the EMA’s, you found yourself in two pretty good trades.

Continuation Trade – One Example

Once we are in a confirmed trend, we can look for the 9 period exponential moving average to cross over the 21 EMA which reverses the short term trend direction.

Our first chart example didn’t really have a trend occuring until after the second trade.

We can use the same rules for a continuation trade:  look for a swing high to be taken out once the 9/21 cross back in an uptrend direction.

continuation buy trade

This a daily stock chart of NIO.  After a very large run up in price, we get a continuation setup.

A legitimate setup with a close above the last swing high as there was a crossover of the 9 moving average to the upside.

Depending on where you place your stop, you’d have participated in the next move of a 35% run in price.

The key to continuation trades is that we need to be in a trend prior to the continuation trade.

Trading Rules – Short Setup

  1. We use the lowest swing low of the range as the area that needs to break to consider shorts
  2. The 21 EMA has crossed the 9 and crossed the 55 EMA setting up a short
  3. Sell the close of the candlestick that forced the moving average crossover

The short setup is the mirror opposite of the buy setup and they share the same vital variable: we need to see a pivot low or high broken before taking the trade.

crude oil shorts

This is a hourly chart of crude oil futures.  You can see the crossover of the averages, the black arrow breaks support level and traders enter short.

This is a very simply trading setup.

The issue is how you work your protective stops, manage your trade, and take profits.

 

Continuation Trade – Second Example

There will be times that the trend is so strong that we don’t get the 9 EMA crossover.

In that case, we can look for a pullback into the 9 EMA and 21 EMA.

Allow price to pullback into the zone and this chart has two trade entries:

  • Failure test entry where price probes below support and is rejected
  • Standard breakout and strong close trade entry

When the moving averages do not crossover, we are in a strongly trending market.  You should have a trading plan that looks to take advantage of these price moves

 

Stop Loss + Profit Taking + Trailing Stops

There are many ways to place your stop loss on these types of trades and there are a few things to keep in mind:

  • Allow room for price to move so avoid a tight stop loss
  • Be consistent

Using the 2 X ATR allows your stop to remain outside the normal volatility and allows price to fluctuate.

Using previous swing highs or lows are a simple visual area but due to the lagging nature of moving averages, the pivots may be far from price

This is using a 2 times the ATR from close for the stop loss.

The target is a 1R and you can adjust your stop, take partial profits, whatever fits your trading plan.

You could use the swing low or just below the entry candlestick.

 

Takeaways

The lagging issue with a moving average crossover strategy can cause problems such as price moving too far too fast. This can have us getting into a trade just when price snaps back to an average price.

The good thing is we can judge momentum based on the separation of the averages as well as the distance price is from the averages.

Adding in the needed breaks of swing levels in all trades except the continuation two method, ensures that price action is showing us a trending price pattern.

Having three moving averages helps us have no doubt if a market is trending or is ranging.

  • If we see separation in the averages, we have a trend
  • If price is whipping back and forth around the averages, we have a range

The first trade out of a reversal and the first pullback/continuation trade, have proven to be the most reliable.

If you don’t blindly trade the 3 EMA crosses, take into account support and resistance, you could find an edge in this type of strategy where you take advantage of trend, momentum, and a simple trade management and profit taking routine.



Author: CoachShane
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.

15 Comments

  • Vijaykumar Bhagat

    When value of the 21 EMA is in the MIDDLE of EMA 9 AND EMA 55 AND EMA 9 IS CROSSING DOWN 21 FROM ABOVE 21 TO BELOW EMA 21. What should be the nature of the trade ? I appreciate your generosity to educate the traders by your so many mails and videos. I have found them ti be educative. They are excellent mentoring .

    • The shorter term trend is down while the longer term trade is still up. In this case, you are probably looking at a deeper pullback in the current trend. Managing the trade tighter than usual would be my next step if long. If not in a trade, I’d have to see some time of price action/structure indicating that the buyers are still in control or regaining control. Good question

  • Rajesh

    which time frame we can use this 3ema means 5mn / 15mn/ 30mn/ 1hour / 4 hour / day

  • Pareshkumar

    You are a great sir thank you 😊❤️

  • padlock

    How long do you hold long, medium and short term plays typically?

    • There is no typical time as the market dictates when it’s time to hit the exits. Since I trade off daily charts, I am always looking at more than 3 days and have held positions for the better part of the year. That is especially true in currencies. There are the very obscure outliers that end the same day due to interventions or words from govt officials.

  • Tre Bailey

    Hi Coach Shane,
    I’ve been reading through a series of training posts on the website and find them to be very helpful. Is there some way to be notified when a new blog post is published or an email list? Thanks !

  • Chandrashekhar Dugam

    EMA 21 is above EMA 55 and price is crossing below EMA 55. Can it be a valid pullback?

    • That will have to be part of your rule set. I would be more concerned with the momentum of the pullback as seen in price. Search through our site as where are a few trading articles on pullbacks and what to look for.

  • Moeketsi

    Thank you for wat u have created..

  • Mahant

    Really good education to me, been in trade market since 3 months, observed and analysed the rules of your 3ema, it works. Have few doubts i will mail you.

    Thanks a lot

  • rasputin

    Just starting, can you explain what the 1R and the 2 x ATR means in the Stop Loss + Profit Taking example? What does 1R mean? What does 2 x ATR mean?

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