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Amazingly Simple 21/55 Moving Average Strategy For Day Trading & Scalping - YouTube
Channel: The Secret Mindset
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Moving averages are among the most popular
and widely used technical tools in trading.
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Because they are used by so many traders,
it is worth having them on your charts to
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know what other traders are looking at.
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Often, in a trend strategy, traders are using
more than one moving average, often a combination
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of slow and fast moving averages.
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In this video, I will follow this approach
and spin it in a slightly different way to
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give you a fresh perspective relating to the
use of moving averages in your trading.
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So, a moving average strategy can help you
to not only identify the “average” trend,
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but also “trend strength.”
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For this reason, you can use more than one
moving average, a slow moving average of 55
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period, and a fast moving one, of 21 period.
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Why these particular numbers?
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Because 21 and 55 are Fibonacci numbers, but
you can backtest and change the values of
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the averages as you like.
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You just need to learn how to read price action,
using this approach.
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So, 21 and 55 moving averages.
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This setup will provide a clearer picture
of trend strength on a slower and faster time
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frame.
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First, let me point out that this is NOT a
crossover strategy.
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While such a strategy for moving averages
is perfectly acceptable and valid for some
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traders, I prefer to think slightly outside
the box and pay attention to a specific repetitive
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pattern when combining a slow and fast period
moving average.
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Now, remember that moving averages “indicate”
conditions in the market.
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They are not surefire signals that tell you
when to buy or sell, we will use them as a
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tactical component within our trading method.
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The main goal behind using a shorter period
moving average with a longer one is simple.
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We are looking for both perspectives in making
a more informed decision.
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While the 21 shorter term moving average will
be located more closely to price resulting
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in more touches, the 55 moving average gets
touched less frequently during a normal trending
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market.
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There exists, however, a different perspective
to following the patterns of slow and fast
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moving averages in relation to price action
and I call it the contraction-expansion principle.
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The contraction-expansion principle is derived
from the Bollinger bands indicator.
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This principle is not based on the moving
averages crossing over, but rather the distance
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between the two moving averages as an indication
of the strength of the trend.
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When in a strong trend, the price will pull
the 21 MA with it, which in turn will diverge
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further away from the 55 MA, causing a larger
gap between the two moving averages.
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This is an expansion.
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As price pulls back, or transitions into a
sideways pattern, the moving averages will
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close in together, often creating a contraction.
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We want the price to bounce right off this
dynamic zone, and breakout into a trend.
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This example illustrates how the two MAs behave
when the market is trending.
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We have a dominant downtrend displaying frequent
but short pullbacks.
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Notice how the distance between the two MAs
is fairly consistent to reflect the smoothness
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and consistency of the trend itself.
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When the market does pull back, it bounces
fairly accurately from the 21 – 55 dynamic
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zone, a price action pattern I noticed is
very common during strongly trending conditions.
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In this other example, notice this extended
pullback and behavior of the moving averages.
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We have here what we call the contraction
of the MAs caused by an extended pullback
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into the downtrend.
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Essentially, the 21 MA gets pulled back up
with the price near the 50 MA, narrowing the
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gap between the MAs.
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If the trend is strong enough, and other factors
permit for the trend to continue, we can expect
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this pattern of the MAs to release price back
in the direction of the trend.
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Keep in mind that like most technical indicators,
moving averages are lagging, which means that
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they react to price rather than price reacting
to them.
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That also means that the contraction of the
MAs isn’t the cause of the resumption of
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the downtrend, but is rather an effect of
price resuming the trend.
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Here we’re looking at an uptrend that slowly
transitions into sideways market action.
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Each of the pullbacks into the uptrend cause
a slight constriction of the EMAs, resulting
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in price shooting back up sharply.
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But as we approach potential key resistance
around the round number, an extended pullback
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does NOT result in price shooting back up
sharply.
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You should note that as price tried to resume
the trend after the last pullback, it stalled
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at the crossover point of the two EMAs and
actually reversed back down.
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This is usually a very strong indication that
we are either entering a period of sideways
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action, preparing for a deeper pullback into
the dominant trend, or entirely reversing
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the trend.
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So, this is the first step in our strategy.
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We analyze price action to find for a contraction
in the moving averages.
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Essentially a pullback into the dynamic support
or resistance area, determined by the 2 moving
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averages.
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By watching how price behaves as it pulls
back to the dynamic zone we can analyze the
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momentum present in the current move.
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Remember that after a pullback to this area,
we are looking for a sharp move back in the
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direction of the trend.
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Next, we need to add other aspects into our
analysis.
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As said before, when looking for a resumption
of the trend at the dynamic zone, it helps
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to analyze if the trend has room to proceed.
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Does the dynamic zone also line up with a
round number or a major horizontal support
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and resistance zone?
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Is the trend headed into a key swing high
/low?
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Answering these questions will help you build
an overall understanding of the market and
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can help give important signs to fine tune
your entries and exits.
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The final step is to trade a breakout, after
the price resumes in the initial direction,
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and the price was unable to break below the
dynamic zone of the 2 moving averages.
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So we chase a breakout, a momentum move, in
the direction of the trend, after we identified
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strength in the market, meaning that the price
found support/resistance at the dynamic zone.
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This means we have buying power, in an uptrend,
or selling power, in a downtrend, at the dynamic
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zone formed by the 2 moving averages, and
we aim to ride the momentum wave.
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But we need a breakout.
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We want a trend line breakout or a swing breakout.
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In this example we have the dynamic zone,
which basically acts as a magnet, because
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when price is too far from it, it tends to
pull price back to this zone.
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Then, as the price was unable to go lower,
which is key in our strategy, as we want to
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see strength and buying power, we also have
a breakout play here out of the wedge pattern
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or triangle pattern indicated by these lines.
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So we have a price action based entry.
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With this strategy, knowledge of candlestick
patterns and price action is very important.
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This is because you will be looking for reversal
candlestick patterns on this area.
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Patterns such as engulfing candlesticks and
pin bars are ideal as a trade entry.
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Because our strategy is based on a dynamic
zone in the form of the 21 & 55 MA, we will
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also use these dynamic areas as our basis
to set our stop loss, below or above it, depending
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on the trade we take, in this example, below
it.
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This is a conservative stop.
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A more aggressive stop is below the most recent
correction.
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As for target, I aim for at least 1:1.5 risk
reward ratio.
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Here is a short SETUP.
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We have the contraction zone here, tested
several times by the price.
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Observe that price was unable to go through
this area.
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This means we have active sellers in this
zone, ready to push price back down.
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We enter short, after the breakout of this
range.
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You might ask, why we have to wait for a breakout,
and why not entering short when price was
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in the contraction zone.
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Well, because in real time, we don’t know
if the price will indeed reject the dynamic
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area.
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It might push through the zone, and go the
other way.
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We need a clear sign or confirmation that
price wants indeed to go lower.
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So don’t try to gamble and enter earlier,
without breakout confirmation, because that’s
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not the point of this strategy.
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So, to be crystal clear, wait for the price
to return to dynamic zone, the 2 moving averages
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must not cross each other during this pullback,
and after the price rejects the dynamic zone,
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search for a breakout in the direction indicted
by the 2 moving averages.
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The best tip I can share with you is to always
pay attention to the slope of the 55 moving
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average.
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The slope of the 55 moving average can tell
a lot about the strength of a trend.
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When the 55 moving average shifts from strongly
pointing upwards during a bull trend, to going
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sideways, it can provide early warning signals
about a shift in sentiment.
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So pay attention to it.
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Here are several examples of valid trades.
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This is not a perfect strategy, you will encounter
losing trades and for this reason you could
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add your personal spin on it, additional confirmations
or other types of analysis.
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Just make sure you don’t overcomplicate
it and stick to the main concepts of this
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strategy: rejection of the dynamic zone and
a momentum move in the direction of the trend.
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As always, if you learned something new and
found value, leave us a like to show your
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support, subscribe to our channel and click
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new videos.
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Until next time.
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