Definition and Example of the Moving Average Bounce Trading System
Stock prices naturally swing up and down throughout a trading period, but these swings tend to stay within a specific range, generally trending up or down.
The moving average bounce trading system uses a short-term time frame and a single exponential moving average to give slightly more weight to more recent price movements. It allows traders to observe where stocks move and to time their trades with bounces as they bump against the average trade line.
This method works for long or short trades, where the trader watches for specific indications on a trading chart and then trades the stock as it moves away from, reverses, and then bounces off the moving average line.
In a long trade, a trader purchases a stock to hold in hopes of seeing the price increase so they can make a profit on the sale. In a short trade, a trader will sell a stock at a certain price, anticipating that they will repurchase it when the price drops, thus making a profit on the difference.
How the Moving Average Bounce System Works
A moving average removes short-term fluctuations from a chart line, demonstrating an investment's overall direction and trend. This creates a smoother-appearing price line. When the price experiences a strong move, the line will track back to the moving average but then continue in the original direction it was moving—the moving average bounce trading system uses this bounce.
The default trade uses a one- to five-minute open, high, low, and close (OHLC) bar chart and a 34-bar exponential moving average of the typical price (high, low, and close, or "HLC"). Both the chart time frame and the exponential moving average length can be adjusted to suit different markets. The default trading time is when the market is most active.
How to Use the Moving Average Bounce System
This method can and should be used, exactly as presented, in whichever markets you are trading. The trade used in this tutorial is a long trade, using one contract, a target of 10 ticks, and a stop-loss of five ticks. The target and stop-loss are options chosen by the trader based on their level of comfort for the options they are trading.
1. Open a Chart
Open a one-minute OHLC bar chart of your market.
2. Add an Exponential Moving Average
Add a 34-bar exponential moving average of the HLC typical price (high + low + close divided by 3), also known as the "HLC average."
3. Wait for Price and Moving Average Divergence
Watch the market, and wait until the price has moved away from the moving average. There is no standard distance the price should move, but the price bars should no longer be touching the moving average. For this example, the distance is approximately 10 ticks.
4. Wait for Price and Moving Average Convergence
Look for the price to reverse, and begin heading back toward the moving average.
5. Wait for Price and Moving Average to Touch
You want the price to touch the moving average, which happens when the price trades at the current moving average price. For a long trade, the previous price bars should have been making lower lows as the price approached the moving average, and for a short trade, the previous price bars should have been making higher highs as the price approached the moving average.
There is no specific number of bars that need to make consecutive lower lows or higher highs, but some traders use at least three bars. For example, in this chart, the price touches the moving average on the fourth bar to make a consecutive lower low.
6. Enter Your Trade
Enter your trade when the high (or low) of the first price bar that fails to make a new low (or high) is broken. For entries into a long trade, follow these steps:
- Price bars make lower lows.
- Price bar touches the moving average.
- Subsequent price bar fails to make a new low.
- Subsequent price bar breaks the high of the previous price bar.
If you are going to enter a short trade:
- Price bars make higher highs.
- Price bar touches the moving average.
- Subsequent price bar fails to make a new high.
- Subsequent price bar breaks the low of the previous price bar.
In the trade shown in this chart, the bar that failed to make a new low is shown in white, and the entry is shown by the arrow. The entry would be $1.2995, with a target of $1.3005 and a stop loss of $1.2990 (ticks of 10 and five).
There is no standard order type for the moving average bounce trade entry, but many traders recommend a limit order for some markets.
As soon as your entry order has been filled, ensure that your trading software has placed your target and stop-loss orders, or place them manually if necessary. There is no single order type for either the target or stop-loss, but for most markets, the minimum should be a limit order for the target and a stop order for the stop-loss.
7. Wait for Your Trade to Exit
Wait for the price to trade at your target or stop-loss and for either your target or stop-loss order to be filled. The moving average bounce trade can take anywhere from a few minutes to a couple of hours to reach your target or stop-loss, and the trade does not use any target or stop-loss adjustments (except moving the stop-loss to break even at a suitable time).
The targets that are shown on the chart are at $1.3005 (10 ticks), $1.3015 (20 ticks), and $1.3025 (30 ticks), all of which were filled by this trade.
If your target order has been filled, then your trade has been a winning trade. If your stop-loss order has been filled, then your trade has been a losing trade.
8. Repeat the Trade
Repeat the trade from step four as many times as necessary until you reach your daily profit target, or your market is no longer active.
- The moving average bounce trading system watches the ups and downs of a stock price to create an average trend line for price movement.
- Traders use this average to maximize profits by trading off the "bounces" when a stock rebounds against the average direction.
- The bounce system works for long and short sales and can be repeated throughout the day.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.