While the traditional moving average cross over method offers a fairly decent trade set up, in times of ranging markets, the crossovers of the moving averages can get choppy resulting in quite a few losing trades. Instead of buying and selling on bullish and bearish crossovers of the moving averages, trading the retracements after the crossover can offer a fairly reliable trading strategy with a minimum of 1:3 risk reward.
In this trading strategy, EMA Crossover with Fibs, the basic chart set up is very simple. The indicators used are:
- 20 Period EMA applied to closing prices
- 55 Period EMA applied to closing prices
The indicators are applied to the H4 charts.
EMA Crossover strategy – Basic guidelines
The 20, 55 EMA crossover strategy works on the following principles.
- When the shorter period moving average cuts below the longer term moving average, the bias is to the downside. Similarly, when the shorter period moving average cuts above the longer term moving average, the bias is to the upside.
- By using the Fibonacci retracement tool, we then measure the swing pivots high and low
- Trades are entered at the 38.2% retracement with stops at 61.8% retracement. For targets, we use the 127.2% as the first target followed by 161.8% for the second target
- The Fib levels shows us how the targets are always higher than the risks for the trade
The chart below shows a typical set up, which is explained in detail later in this article.
In the above chart, we measure the swing high and low, prior to and after the bullish crossover. Trade is entered when price retraces to the 38.2% Fib level with stops coming below at 61.8% Fib level, targeting 127.2% and 161.8%.
This trading strategy requires traders to be alert, especially after the EMA’s crossover as the retracement to 38.2% is very quick in most cases with price usually making a long dip to the 38.2% Fib level before it starts to move in the direction of the trend.
EMA Crossover Strategy – Buy/Long Positions
- 20 EMA must cross over the 55 EMA on the H4 charts
- Switch the chart to a line chart and using the Fib tool, measure the most recent low swing point prior to the bullish crossover to the most recent swing high above the EMA crossover
- Ensure that the 38.2% retracement is close to the 55 EMA. If the 38.2% retracement level is far below the longer term EMA, then wait for price action to give further clues
- Stops are placed at 61.8% retracement targeting 127.2% and 161.8% Fib levels. Ensure that by the time price reaches 127.2% Fib level, your trades are moved to break even.
The chart below gives an example of a buy set up using this strategy. We make use of the line chart to illustrate how to use the Fibs to measure the swing high and low points that are created.
- We identify a bullish EMA crossover as the 20 period EMA cuts above the 55 period longer term EMA
- Using the line chart, we then identify the swing low, just before the crossover and the swing high at or after the crossover. We then use the Fib tool to measure this distance
- A buy order is placed at 38.2% Fib retracement as there is a strong confluence with the Fib level and the 55 period EMA
- Stops are placed at or below 61.8% Fib level (mind the spread)
- We book profits at 127.2% and 161.8% Fib levels
EMA Crossover Strategy – Sell/Short Positions
- The 20 EMA must cross below the 55 EMA on the H4 charts
- Switching to line charts, we use the Fib tool to measure the first swing high and the last swing low prior to and after the bearish EMA crossover
- Short position is entered at 38.2% Fib level with stops at or above 61.8%, targeting 127.2% and 161.8%
The following chart shows an example of a short position
- The EMA 20 cuts below EMA 55 triggering a bearish crossover of the moving averages
- Measure the swing high prior to the bearish crossover and the swing low after the bearish crossover
- Look for confluence of the 38.2% Fib level with the 55 EMA and enter a sell order
- Place stops at or above 61.8% Fib level, targeting 127.2% and 161.8%
20, 55 EMA Crossover Retracement Strategy
This strategy is one of the simplest and offers a very good risk/reward ratio for all trades. The most ideal trades are those where the 38.2% Fib level shows confluence with the 55EMA, thus increasing the odds. Unlike trading based off the moving average crossovers, the retracement method allows us to enter only after a trend is established. Furthermore, the defined risks ensure that all trades have a good RR, thus making this is a very robust trading strategy to follow.
By using only the H4 charts, this trading strategy is suited for traders where the average trade holding time can be from a few days to a week or two at the max.