Moving Average Bounce Trading System

Updated on April 4, 2024
Article byPrakhar Gajendrakar
Edited byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Moving Average Bounce Trading System?

The moving average bounce trading system represents the stock price variation, both upside and downside, to devise a middle price trend line. This trading system is a chart that investors can use to seek the stock’s direction. This strategy aims to take advantage of price reversals or bounces at key moving average levels.

Moving Average Bounce Trading System

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The average trend line showcases the price range in which the stock price varies, and investors use it to deduce the average stock price and spot price fluctuations, also known as bounces. Hence, to make a prosperous trade and register maximum returns when the stock price makes a bounce against the trend line. Traders use this trading system in various financial markets, including stocks, commodities, currencies (forex), and other tradable instruments.

Key Takeaways

  • The moving average bounce trading system depicts the stock price movement creating a trend line. Furthermore, investors spot the price bounce against it to execute successful trades.
  • Investors can repeat this investing strategy multiple times daily and can implement it for both long and short trades.
  • Bounce trading involves the combination of divergence and convergence of the price bars. Additionally, the moving average indicates the price direction in the market.
  • In a long trade, traders must fulfill the target order. In a short trade, traders must fulfill the limit order.

Moving Average Bounce Trading System Explained

The moving average bounce trading system is the strategy to monitor an underlying stock’s short-term past moving average to forecast the direction it is moving in. Hence, the price chart defines a middle trend line which plays an integral part in watching the market. In a regular active market session, the stock prices fluctuate dynamically. Besides, moving in a particular range, not with extreme variations. Therefore, it sets an average price range in which they typically swing.

Additionally, this bracket offers an average trend line. Depending on the stock and its current trading price. The price bars either move on the upside or downside of the middle line. Furthermore, the moving average bounce trading system allows an investor to watch and observe the price swing and spot specific indications to enter and exit the trade. The whole strategy execution can occur in minutes or hours, depending on the price bar movement. However, traders can apply it multiple times within a single day during an active market session.

Moreover, the investor can apply the moving average bouncing technique for long and short trade. Hence, in the former, the investor buys a stock and holds it expecting the price to increase, making a profit. Conversely, in the latter, an investor sells a stock at a specific price in anticipation of rebuying it. Hence, when the price declines and realizing the profit from the price difference. Therefore, combining this strategy with other technical analysis tools, risk management techniques, and proper evaluation is crucial to increase its effectiveness.

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How To Trade?

The steps to implement a trade based on a moving average bounce trading system are as follows –

  • Select the time frame and market:  Determine the time frame you want to trade on, such as daily, hourly, or shorter intervals.
  • Set an exponential moving average – Once the chart is opened, the investor can set an exponential moving average for different time frames; the moving average is made up of open price + high price + low price divided by 3.
  • Look for price and moving average divergence – An investor has to wait for the price to move away from the moving average. Since the price is moving away, traders refer to it as divergence, and there is no specific distance associated with it. Moreover, the price bars should not touch the moving average. But it may take time,, so an investor has to monitor the market carefully.
  • Wait for price and moving average convergence – Once the divergence is spotted, the investor has to again patiently wait for the price bars to come back.
  • Spot the price bar making contact with the moving average – When the prices fall back to the moving average. Thus, the investor has to wait and look for it to touch it. When it happens, the underlying stock’s price parallels the current moving average price.
  • Enter trade – An investor can enter the business after the contact, ensuring that the software has automatically placed the target or stop loss order. If required, an investor must do it manually.
  • Wait to make a trade exit – It is the most time-consuming step. Since the price variation is dynamic, the bounce can take a few minutes to multiple hours to arrive at the target or stop loss. Traders consider the trade a success when they fulfill the target order. Conversely, they consider it a losing trade when the stop-loss order is touched.

Chart

Let us look at the following chart to understand the concept better:

Moving Average Bounce Trading System Chart

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The above chart shows the currency pair of EUR/USD, and its bounce against the 200-day moving average as observed. The red line is the average trend line, and above that are the price bars, which at first diverge and then fall back in convergence to touch the trend line. The 200-day moving average is a popular metric because it is a large stock price movement data set and is considered good support or resistance.

Hence, it applies to different markets so that investors can visit and study the price chart of different securities. Furthermore, the system uses the exponential moving average of the stocks, allowing more weightage to recent price variations. The investor applies it for long and short trades and watches the trading chart indications. Hence, to spot stock price movements and when they bump or bounce against the average trend line.

Examples

Below are two examples of moving average bounce trading systems, one hypothetical and the other from a real-world scenario –

Example # 1

Let’s say David is a stock market investor. He has been trading for more than a decade. Therefore, whenever he decides to invest in a stock, he first uses the moving average bounce trading system to analyze its price direction and spot the right time to execute a good trade. He has been pursuing an oil company stock for some time and planning a long trade. David opens the OHLC (Open High Low Close) chart and sets the default exponential moving average. The trend line appears.

Hence, after watching the market for nine minutes, he finds that the price bar diverges and then converges. Since David is planning for a long trade, the previous price bars should make lower lows (from upside to downside) as the price approaches the moving average. Just after four price bars, the price touches the average line. David enters the trade and waits for it, it takes a while, but the target order is fulfilled, so David’s trade is a success.

Example #2

For the first time in 2022, Ethereum (ETH) has surpassed a crucial technical milestone, trailing market leader Bitcoin (BTC). However, one expert who monitors price chart patterns advises against anticipating swift price rallies for Ether.

On July 18, 2022, Ether rose over the 50-day SMA (simple moving average)  and reached a one-month high above $1,500. The cryptocurrency was trading at $1,525 at publication, with the 50-day SMA at $1,327. At $23,000, Bitcoin is still below its 50-day SMA.

According to Stockton, a chartered market technician and the founder and managing partner of Fairlead Strategies, the bounce may only last a short while. Short-term overbought conditions have returned, and Ether has cleared its 50-day SMA, improving sentiment towards altcoins [alternative cryptocurrencies], but the bounce may be fleeting.

Frequently Asked Questions (FAQs)

1. How suitable is the moving average bounce trading system for beginner FX traders?

Moving average bounce trading is used in FOREX to either long the currency pairs as solid support in the uptrend or to short the pair as a resistance in the downtrend while bouncing the moving averages. For beginners in the FOREX market, online trading is helpful as they can practice it from their demo account.

2. Is the moving average bounce trading system 100% accurate?

No, there is no technical indicator or trading system that is one hundred percent accurate; just like in any other method, the moving average bounce trading system also has error and price divergences that occur occasionally, and hence it is highly recommended to investors to set stop loss and take profit levels and use of proper risk management tools.

3. Can the moving average bounce trading system be used in all market conditions?

The moving average bounce trading system works well in trending markets where the price bounces off the moving average and continues toward the trend. However, in ranging or choppy markets, where the price moves sideways around the moving average, the strategy may generate false signals or lead to whipsaws.

This article has been a guide to what is Moving Average Bounce Trading System. Here, we explain it with its examples, how to trade it, and a chart. You may also find some useful articles here –

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