Moving Average Mania: Using Multiple Moving Averages with ADX to Trade
Have you ever snorted an unknown brown powder in a beer house in Germany?
Have you ever met someone that asks a lot of questions and then wants proof of the answers? That person that just has to find out on their own; to a large extent that is how I am. I wish I wasn’t, it would make my life a lot easier, not as exciting; but easier none the less.
I remember right after college when my roommate and I went backpacking through Europe. It’s a funny thing that people say “backpacking” across Europe. Yes we had backpacks but there was very little backpacking, mostly riding on trains. Anyway, I digress; we were sitting there in Munich, Germany, at the famous Hofbrauhaus (beer house) drinking a beer or two.
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Sitting across from us was this older German man drinking his beer, minding his own business. We were not talking because I don’t speak German and he did not speak English. Other than saying hi, I didn’t pay to much attention to him. But when he took a small box out, what I thought was a tick-tack box, and opened the corner so that he could sprinkle this brown powder onto the area between his thumb and pointer finger; it aroused my curiosity.
He then proceeded to snort this powder up his nose. Having seen this, I had to ask what it was. The only powder I knew of that people snorted was white and very illegal even in Germany. I asked the German man what it was but he didn’t understand me. The guy sitting next to him spoke both English and German, so he translated for me. He said it was snuff tobacco. At that point I was relieved that it wasn’t the white stuff.
The German man said something that I didn’t understand, but by the way he was gesturing I got that he was offering some to me. This is where I should have lessened to my friend and as I came to find out the man offering it to me. So, against my better judgment, I put my hand out and received a little bit of this powder. As I did this the German man said something else, but by the time I received the translation it was to late.
What the German man had said as I partaked was that I would not like it. He said this as he scooted back in his chair and covered his beer. He was right about not liking it. This was the first and last time that I would ever snort anything. I started sneezing and coughing and the powdered tobacco started draining into my throat. It was not a pleasant experience.
You would think that after this experience that I would be a little less inquisitive or at least take the answers I receive at face value. Well to the elation of my wife and business partners, I have slowed my response to my questioning. But I believe that it’s due to age, more than any one experience.
What has not changed is the fact that I question. This has served me very well in the Forex market and you also will reap the rewards of my questioning nature. You see, I recently came across a trading system that started me thinking. So, instead of taking the time to trade it and see if it worked or taking the author of the system at their word; I spent the better part of a week coding and testing this system.
The results of my testing are below. But if you want to trade this system or a variation of it, I would suggest further testing.
Multiple Moving Averages with ADX Confirmation
I have limited this report to the testing of a system that uses simple moving averages (SMA) and the Average Directional Index (ADX) indicator. I have not taken the time to explain how these indicators are derived. Due to the fact that most of y’all know what a simple moving average is and the length of time that it would take to explain the ADX indicator. I will elaborate on how the ADX indicator is used.
The ADX indicator is the combination of indicators. The theory behind the ADX indicator is that it measures whether or not the pairs under study are in a trending mode or not. The ADX indicator fluctuates between 0 and 100, a reading of 20 or more indicates that the pair could be in a trending mode. This indicator is fairly slow and caution must be used when applying it because it takes time to adjust to currency pair movement.
Moving Average Mania Trading Rules
We are going to use a 10 period SMA, a 20 period SMA, a 50 period SMA, a 100 period SMA, a 200 period SMA, and the ADX indicator. We want the ADX indicator to read 20 or more, in an upward curve. We also want the moving averages to all be in order on the chart. For example, a Buy order would be generated five days after the 10 period SMA is greater than the 20 period SMA, the 20 SMA is greater than the 50 SMA, and the 50 SMA is greater than the 100 SMA, and so forth.
A sell short order would be generated 5 days after the exact opposite occurs, with the 200 SMA being the greatest, with the 100 SMA under it and so forth. This will become clearer with the examples below.
The exit is generated when the moving averages move out of there order. If you are familiar with moving averages you know that the exit will occur when the 10 SMA and the 20 SMA cross. I have tested a few other exits without any good results.
The initial stop loss for a buy order is placed at the low of the period when the moving averages lined up. This would be the low of five periods before the entry. The stop loss for a sell short order is placed at the high of the past five days before entry. Through testing, I found different places to put your stop loss depending on the trading criteria.
Tests were conducted on weekly, daily, and 60 minute time frames.
Example 1:
The chart below shows an example of a profitable buy. The first up arrow from left to right is below the day (period) when the moving averages sequentially lined up, our setup. The stop loss will be placed at the low of this day.
The second up arrow is the fifth day after alignment and sense the order has held and the ADX is over 20 and rising, I have bought at the close of the day. The down arrow indicates the exit when the 10 day SMA and the 20 day SMA cross. The sequential order has been broken and we are out at a profit of 94 pips.
Example 2:
The chart below is an example of a profitable short. From left to right, the first down arrow is the day that the moving averaged lined up in order from 200 SMA down to the 10 SMA. The stop loss was placed at the high of this day.
Five days later we sold short at the close, indicated by the second down arrow. The moving averages had held their places and the ADX was above 20 and climbing. The up arrow indicates the exit day. As you can see, the 20 day SMA dropped below the 10 day SMA signaling the exit of this trade.
Test Results from Weekly Bar Charts
The results that were derived from testing on the weekly time frame where not what I would have expected. I anticipated that there would have been more trades than there were, two to five over a twenty year period. I also thought that it would have been more profitable than it was. The reason that I thought it would be more profitable was because the weekly time frame tends to trend more than the daily or hourly time frame. I thought that this would have given the moving averages a better chance at triggering a trade using this system. I have not included the test results because they were not note worthy.
Test Results from Daily Bar Charts
On the daily bar chart, this system did alright but did not trade very often about once a year. The system definitely catches the short, mid, and long term trend; all going in the same direction. The only thing is that it gets you in the trade late and gets you out late. I did test about five different exits, but none that I tested showed improvement.
You could put this system in the war chest and pull it out to trade it when it comes along.
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Test Results from the Hourly Bar Charts
I was hoping to trade this on an hour bar chart. This way there would be more trades. There are more trades but there are more losing trades. Plus, the pairs that are profitable are not that profitable. The other issue is that some of the pairs are profitable while others are not. This has always bugged me a little. I know that there are systems that should only be traded on one pair. I understand that the pairs have their own personalities, but a system that can be profitable across several pairs is more stable, at least in my mind. I would only trade this system on the daily bar chart.
You might be able to trade this on the hour bar chart using a breakeven stop. Your over all winners would go down but your profitability should go up. I would suggest further testing if you are going to take this approach.
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Results from Variations Tested
While working on this report, I tested over sixteen different variations of the original system. I removed each of the SMA until there were only two left, starting with the 200 SMA and working my way down. Then I removed the SMA going the other way, starting with the 10 SMA and working my way up. I conducted tests were there was no time delay in placing the order. Instead of waiting five days for confirmation, I placed the order as soon as the SMA lined up in order.
I also tested different ADX variations. I tested having the ADX above 20 and below 20. I looked to the difference between having the past five days above 20 and having the ADX rise over the past five days. There were several other variations tested, but I have not mentioned them here.
The most promising combination of SMA’s and ADX that I tested has been included below. I call it the 10/200 ADX system. I have included it for your edification and help in further testing and research.
The example below is an example of a profitable buy order on the hour bar chart. The rules for this system include a 10 SMA, 200 SMA, and ADX(14). When the 200 SMA crosses over the 10 SMA and the ADX has been above 20 for the past four days and is rising everyday from day four to the present.
Above the up arrow is the bar where the 200 SMA crossed over the 10 SMA and the ADX has been increasing above 20 for the past four days. The trade is exited when the 10 SMA crosses over the 200 SMA and the ADX has been above 20 for the past four days and increasing.
Believe it or not this is a counter trend system therefore you can not use the low of the past five days as your stop loss.
Example 1
The chart below demonstrates a sell short trade. The down arrow to the left is above the bar of entry. It is also the bar where the 10 SMA crossed over the 200 SMA. The ADX was above 20 for the past four days and rising.
The up arrow on the right is below the bar where the 200 SMA crossed over the 10 SMA. The ADX has been above 20 for the past four days and rising.
Example 2:
I have included the test results for this system. The tests were conducted without a test loss, so the results could be better. The tests did not roll up the account, therefore; the results would be better if you just traded more lots each year.
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Summary
When I came across this system it was presented without any, what I like to call; background information. The rules were presented and charts shown, but no test information. It did not say what time frame to trade it on, how many trades I could expect in a year, and/or what the return would look like.
I hope by presenting this information you will want to test and conduct research, or at least find the people that are will to give you this information up front. I know that the limited testing that I have done in this report on the 10/200 ADX system needs to be added to, but I have given you a solid ground to start from.
With that, I think it’s time to bring this report to an end. I hope you take what I’ve talked about and apply it to your own trading. If you do, please let me know your results. I’m always on the lookout for other traders who I can bounce ideas off of and share test results. Until next time…
Good trading,
Jason Fielder
Developer, Forex ImpactTM
P.S. I will be uploading videos about the 10/200 ADX system to the FX Insiders Club within the next month. I hope that this will answer any questions you may have. Also, feel free to ask questions on the forum.
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