moving average crossover Archives - Algorithmic and Mechanical Forex Strategies

Beware of a Fake Trading Signal

October 29, 2015 by Lior Alkalay 9 Comments

How many times were you certain of that one trading signal that told you that a trend was over? Or what about the one that indicted a trend was just about to begin? Of course, that “prophecy” was eventually dispelled and the market turned against you. It probably happens quite a lot, maybe even more than you’d care to admit.

Those are fake signals. That’s when you think you’re getting a clear signal, but… you aren’t. Sometimes identifying a fake trading signal can be tricky. Often, a little alertness can save you the pain of following the wrong trend. In this article, I will focus on some tips that will allow you to avert some of the more common fake signals.

Moving Average Fake Trading Signal

This is a classic fake trading signal. The Moving Average Cross, where the fast moving average crosses the slow moving average, signals a trend change. For this example, let’s look at the chart below. When the fast moving average (blue) crossed above the slow moving average (green) the trend didn’t change. In fact, the fast moving average later crossed the slow a few more times.

Source: esignal

How Can You Avoid this Tricky One?

You must validate the change of trend signal with another trading signal. For example, in our sample, the pair had not broken the 1.17 resistance that caps the pair in bearish territory. We can’t expect a trend to be changed before the resistance that trims that trend has been broken.

Another helpful tool would be to move one level up and run a long term EMA. In the case of weekly, 52 weeks is the most effective in giving a general indication of momentum. Again, it’s not definitive by itself.

First you need to determine if the moving average cross suggests a changing trend. Then, see if key resistance has been broken. If both have, then the pair should also trade above its 52 week EMA. As we can see, those conditions were not fulfilled. The combination of the supplemental conditions should lead to one conclusion. That is that trading signal was, indeed, a fake moving average cross signal.

Source: esignal

The Fake Double Bottom

The second most common fake trading signal is the fake double bottom. The Double Bottom is a classic signal traders often rely on. When you see the pair forming that classic M shape you instinctively take the opposite trade. Then you ride out the counter bullish trend. After all, if this is a bottom, the pair can only go up right?

But as is clearly shown in the chart below, the trend didn’t change. And after reaching the shoulder (see chart) the pair flipped again into bearish and broke the support.

Source: Financial Times

How to Avoid this Trap

In order for the double bottom M shape to confirm a trend change the pair must close above the shoulder. If it doesn’t, the trend is capped on a bearish momentum. Then the likelihood for the trend to continue with its bearish trajectory is high. A close above the shoulder, however, is a good validation that the trend is bottoming.

Fake Correction

This is another classic; you get a trend line broken(in blue) and immediately conclude that the trend is going to flip. Of course, you jump on the band wagon and open a short. Later, you encounter a brick wall at support and have the bullish trend resume.

Source: esignal

Once again, my main tip here is to go one level up. Now you can see the broader channel and clearly see that we are still within the trend. That way you save yourself from a false entry.

Source: esignal

Fake Fibonacci

Closing out our list is a pure classic: the fake Fibonacci trading signal which is support that you mistakenly rely on. This is usually driven by human error of stretching from the wrong points.

How to avoid the Fake Fibonacci?

The Parabolic SAR is very effective at this. Luckily, this is a subject we’ve already covered and you can read all about it here.

In Conclusion

There are many, many more fake signals and an equal number of ways to identify them. The problem is very often you won’t be able to spot the fake. But at least, with these basic rules of thumb, you’ll get an edge up. If you can spot the obvious ones you can improve your statistics and your odds. And trading is all about tilting the odds in your favor.

Swing Trading Strategy: The Golden Cross and Death Cross

October 27, 2014 by Shaun Overton 3 Comments

Swing trading broadly refers to a segment of trading strategies that combine technical momentum and pattern recognition with a smaller emphasis on fundamental analysis. On the whole, swing trading is a great strategy for individuals unwilling to the devote the time and energy necessary for successful day-trading while seeking to be more active in managing funds than simply participating in buy-and-hold strategies. This strategy is largely employed by speculators and retail investors seeking to benefit from the confluence of short-term price momentum and economic fundamentals. This requires a modicum of flexibility unavailable to large institutional investors that are bound by large trade sizes and are often less adaptable to evolving short-term conditions. The time horizon for swing trades is typically a day to several weeks depending on the investor’s strategy and risk tolerance.

Two very famous technical patterns that fall under the category of swing trading strategies include the “golden cross” and “death cross”. Each of these strategies depend on the trends of moving averages, specifically the 50-day and 200-day moving averages (taken from closing prices). These technical patterns rely on more medium-term charts, primarily 4-hour to 1-day charts. Periodicity is especially important as shorter-term charts are not relevant and useful in assessing these patterns.

Golden Cross

The golden cross is a technical pattern where the shorter-term 50-day moving average crosses a longer-term 200-day moving average to the upside. This is a bullish pattern, signifying a situation where upside momentum is forecast to increase, marked in conjunction with higher than average volumes. The 200 day moving average also becomes a support level for prices. This pattern is currently evident in the U.S. dollar index (DXY) which has witnessed a meteoric rise of 6.87% since the 50-DMA crossed the 200-DMA to the upside on July 16^th.

Death Cross

The death cross, although dark in name, is merely the opposite of a golden cross, with the shorter-term moving average crossing the longer-term moving average to the downside. This is typically indicative of a possible bear-market on the horizon and is usually confirmed by higher than average trading volumes. After crossing, the longer-term moving average serves as a resistance level for prices and is a great area to short the instrument on momentum pullbacks. A great present-day example of the death cross is in the West Texas Intermediate crude oil benchmark which saw the 50-dma cross the 200-dma on July 22^nd, causing losses to-date of -17.12%.

Suggestions for Swing Trading the Golden Cross and Death Cross

Speed is Key

The earlier the entry to a momentum trade the better the risk-reward conditions. As the phrase goes, the early bird catches the word. Quick entry also means more security in exiting a position without worrying about momentum chasing from picking a bad entry point.

Choose Liquidity

A careful exit and entry strategy is essential for any successful trade, especially in the shorter-term time horizons. Instruments that don’t trend for long periods of time and lack liquidity for entering/exiting position are not useful in this particular strategy no matter how pretty the setup. In thinly traded stocks, traders might encounter a sharp price impact from entering/exiting which is likely to create problems for strategies that require nimble maneuvering.

What Not to Do

Avoid fundamental analysis. Although swing trading typically relies heavily on careful reading of the technical indicators, fundamental analysis can still have a dramatic impact on an instrument’s price. Keeping up to date with the news, having familiarity with economics if trading currencies, or earnings if trading stocks is indispensable when swing trading and cannot be ignored. Remember, information is power.

Fight the trend

While not necessarily a trend following strategy, swing trading requires careful examination of the prevailing trend for benchmarks to which an instrument may be closely correlated. For instance, if finding a golden cross in a stock that is a component of a broader index that is trending lower, the relationships between stocks may negate the pattern. Situational awareness is key.

Chase momentum

If late to a trade, wait for a pullback or retrace before entering. Buying highs and selling lows is every investor’s worst nightmare. Timing is everything, so be wary of eagerness to enter a trade.

Backtesting Biases and Variations

October 3, 2013 by Andrew Selby 4 Comments

Last week, I wrote a post discussing how altering the timeframe of a system can change its results. That got me thinking about other ways that backtesting results could be skewed in one way or another based on user defined data such as the date range and market used. These simple differences can have a tremendous influence on the overall returns of any system, so it is important to pay them their proper respect.

When running backtests, it can be very easy to gloss over the down periods and cherry-pick the big return years. The problem is that you won’t have that opportunity when actually trading a system live. You will need to prepare yourself for the possibility that you select the wrong time or the wrong market to trade a given system. Otherwise, you run the risk of letting these backtesting biases adjust your expected return to values the system cannot possibly deliver.

Adjusting the Date Range

Let’s use our 10/100 Moving Average Crossover System from last week as a base. We tested it from January 1, 2001 through December 31, 2010 on the Vanguard Total Stock Market ETF (VTI). All of our tests last week used a starting portfolio value of $10,000, a 10% trailing stop, and a $7 commission.

MA crosses on VTI returned almost 90% over the last decade.

Based on those settings, our 10/100 MA Crossover System returned 89.8% over ten years. This works out to be an annualized return of 12% with a maximum drawdown of 16.2%.

If we would have started trading this system on January 1, 2003, we would have registered a total return of 39% in the three years of trading until the end of 2005. This would have been good for a 16.4% annualized return with a maximum drawdown of only 6%. As you can see, if we based our strategy on these results, we would be expecting the system to continue to produce these extremely high returns.

On the other hand, if we would have started trading this system on January 1, 2006, we would have seen a total return of only 2.5% in the first three years. We also would have had to sit through a 14.2% drawdown.

It is also worth noting that while the ten year track record of this system from 2001 through 2010 is very respectable, we wouldn’t have known that when we started in 2001. If we actually started trading this system in 2001, we would show a total return of -6.2% at the end of 2002. After two full years trading this system, we would not have had a single thing to show for it. The system didn’t find its first big winner until April 15, 2003.

As you can see, the time you chose to begin trading the 10/100 Moving Average Crossover System could have made all the difference over the course of what was a net-profitable decade. It is very important to keep this in mind when you are struggling through drawdowns.

Adjusting the Markets Traded

The market you choose to trade can have the same affect on your trading as the date you start trading. Let’s look at how the exact same system would have performed over the exact same decade if we chose to trade it on different ETFs.

Trading the 10/100 Moving Average Crossover System on the XLF, which represents financials, would have provided a total return of -9.4% for the decade with a maximum drawdown of 30%. It is obvious to us at this point that financials had a rough time during this period, but we would have had no clue about that when we started in 2001.

The XLY, which represents consumer discretionary stocks, also would have underperformed the VTI. Trading the system on the XLY would have returned a total of 39.4, or 6.4% annually, with a maximum drawdown of 21.3%.

XLY shows a 39.4% return over the same decade

If we would have been fortunate enough to trade the XLK, which represents the technology sector, we would have seen a tremendous total return of 95.7%. This works out to be an annual return of 14.2% with a maximum drawdown of 22.3%.

Once again, we see that decisions like what markets to trade and when to start can have a tremendous influence on our results. This is why it is so important to thoroughly backtest any strategy across many different combinations of date ranges and markets.

Trading Time in Programming

February 1, 2012 by Shaun Overton Leave a Comment

The major automated trading platforms such as MetaTrader 4, NinjaTrader and TradeStation all count time in the same way. This makes it quite convenient for ordering trading strategies and expert advisors; you don’t have to do any mental gymnastics to describe the strategy in different platforms. The consistent arrangement of time makes it easy for us to translate trading strategies across multiple platforms.

We tend to think of time as moving in the same direction as when we read. English speakers, who read from left to right, think of time as moving the same direction. If you speak a language like Arabic that reads right to left, you tend to think of time as marching to the left.

All of these charting platforms are written by speakers of left to right languages. The past is anything that’s not on the far right side. The present is the square on the far right. Each square represents an equal time interval. Traders know these as bars.

A visual display of time and how it's segmented

What tends to confuse everyone ordering expert advisors is that even though time marches to the right, trading programmers count the bars to the left. What makes things more confusing is that programmers always start counting from 0 instead of 1.

Even though time moves to the right, we count it from the right and move back left

If you want to trade a moving average cross strategy that waits for the bars to close, what you’re looking at is “bar 2” and “bar 1”. The way I describe this in the scope of work is the value at two closed bars ago and the value at the last closed bar, respectively.

An expert advisor that uses closed bars ignores bar 0 because it is still open, which causes the moving average values to fluctuate. The only way to know for certain a moving average value at a particular bar is to wait for the bar to close, which means it is no longer bar 0. When a client requests an expert advisor that trades intrabar, they intend to compare the moving averages at “bar 1” with “bar 0”. In plain language, that means to compare the value at the last closed bar with the currently open bar.

Hopefully, this description makes sense when you open a chart and see the bars already loaded. The final confusing element is when a new bar pops onto the screen. The previous examples showed 5 bars on the chart (bars 0-4). When a sixth bar pops up, the count is reset to the new time period on every update.

Say that we’re looking at an H1 chart in MetaTrader and that the current time is 06:00. When the new hour strikes, the chart loads a new candle to represent 07:00. It’s at this time that the count resets.

When a new bar appears, your charting platform resets the count based on the newest bar.