The moving average breakout strategy is one of the simplest yet effective ways to trade. Not only are you entering in the direction of the trend, but you are timing your entry when there is a break of support or resistance. Too many traders simply buy above the moving average and sell below it, without actually giving consideration to when they should enter and exit positions. I will show you how you can enter in the direction of an upward or downward trend when there is a breakout above the moving average for a buy trade and below the moving average for a sell trade.
What is a moving average?
The moving average is a technical indicator that you can load onto charts of all your favourite currency pairs. It is free to use and you can find it in most forex platforms including MetaTrader. When price is above the moving average it suggests that there is a buy trend, whereas price below the moving average suggests a downtrend.
A moving average is the average price of a currency pair over a set period of time. Traders can add just one moving average or have many different time frames on one chart. A popular way to trade with them is the double moving average crossover strategy.
How is the moving average calculated?
The moving average is calculated by adding up all the data points during a specific period and dividing the sum by the number of time periods. For example, a 14-day simple moving average (SMA) adds up the 14 most recent daily closing prices and divides the figure by five to create a new average each day.
What are the best moving average settings?
You can choose any moving average period that you like. The default setting is usually always 14 which is therefore used by many traders. This means that it can have a strong impact on price action. Other popular settings include the 50 moving average and 200 moving average.
Generally speaking, the lower the moving average period, the more trading signals that you are going to get. However, this does mean that there will be more false signals so you should always try to confirm trades by using other technical analysis and confirming the trend on other timeframes.
I personally like to have a few moving averages on my currency pair charts. I would usually look at the 14, 50, 100 and 200 period moving averages. This allows me to filter out the market noise and it makes it easier for me to spot a trend when all of these moving averages line up, as you can see from the chart below.
What is a breakout strategy?
A forex breakout strategy is when you look for price to form support or resistance levels. The more times that price bounces from these levels, the more reliable they can be. Once you have spotted a key level of support or resistance, you can wait for price to breakthrough. This could be an opportunity to enter a trade on the breakout. However, you could also wait for price to retest the level to make sure it holds up before taking a position.
For example, if price breached a resistance level and came back down to test it without going back through, this resistance level could now become support. We could then look for an opportunity to get in on the breakout that has just occurred with a pullback trade.
How to trade the moving average breakout strategy
Now that we have covered the basics of moving averages and trading breakouts, lets combine both of them to create a simple yet powerful moving average breakout strategy. We will use a simple moving average (SMA) and some additional technical indicators along with price action to time the entry inline with the overall trend. Yes, you can simply trade a breakout of support or resistance with an SMA alone, but I think the extra confirmation can help to filter out some of the false signals.
Buy signal
- Price is above the moving averages (14, 50, 100)
- Stochastic main line is above the signal line
- Stochastic is below 80 level
- Price breaks out above resistance
In the GBP/USD 4-hour chart below, you can see that the 3 moving averages all suggest an uptrend. The stochastic crossover shows bullish momentum and price has already broken through resistance and retested it to form a new support level. The candlestick patterns are also suggesting buyers are winning the battle over the sellers. We could have used the 50-period SMA as a stop loss level which would be around 60 pips which isn’t bad when an exit of price crossing back over the 50 SMA would have been over 250 pips.
Sell signal
- Price is below the moving averages (14, 50, 100)
- The ADX is above the 20 level
- The ADX -DI is above the +DI
- Price breaks out below support
As you can see from the GBP/USD 4-hour chart below, all of the above conditions were met. There was a strong 3 moving average crossover signal, price was below all of the moving averages and a level of support that had been tested a few times was breached. The ADX indicator is showing strong bearish momentum and there is a hanging man candlestick pattern for further confirmation. We could have placed the stop loss above the moving averages which would have been around 70 pips. This is great when you consider this short trade reached over 700 pips. The exit could have been the moving average crossovers or price going back above the 100-period SMA.
Moving average breakout strategy Pros & Cons
Pros
- Catch some big trends
- Can be used on any currency pair
- Can be used on any chart timeframe
- Easy to understand
- Can combine with any other indicators
Cons
- Signals need to be confirmed for better entries
- Requires sensible money management
- Need the ideal market conditions
Conclusion: is the moving average breakout strategy any good?
Yes, trading breakouts inline with trend can be a very powerful forex strategy when done correctly. Granted, you will need to take some initiative and use other forms of market analysis to confirm buy and sell signals to give yourself that extra edge. Not to mention, you will need good forex money management and control of your emotions in order to get the most out of your trades.
A forex demo account can be a great way to practice the moving average breakout strategy. This will help to improve your trading skills and can make you a better trader without needing to take any risk. You can get a free forex account from most brokers, including IC Markets who are one of my top choices for manual and automated forex trading.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
