Moving averages are truly versatile and universal, and provide traders with many possibilities of usage, limited by traders’ imagination only. In a previous material we have already discovered how two moving averages may be combined to form a working analysis tool for trading. However, there are techniques that require a further increase of the moving averages’ amount. This time we will be exploring the Moving Average Ribbon method.
What is the Moving Average Ribbon method?
A formation of several moving averages, plotted around the price chart in a ribbon-like shape is used to determine the strength of the trend as well as set multiple support and resistance levels. The ribbons’ crossings may also help identify possible trend reversals and optimal conditions for trade entries.
The moving averages are set with intervals between them to form a chart-plotting net. At the same time, traders are free to choose the amount of moving averages that they want to use: it can be a simple or a more complex structure, depending on the trader’s preference.
How to trade with the Moving Average Ribbon indicator
The Moving Average Ribbon system can be used in many ways. Parts of the system may become support and resistance lines, while the width of the corridors might indicate the strength of the ongoing or emerging trend.
One of the many possible ways to set up the MA ribbons is to use 10 Simple Moving Averages, splitting them equally between short and long timeframes. With this approach, 5 SMA indicators are set with short intervals (4,7,11,14,17) and 5 — with longer intervals (30, 35, 40, 45, 50).
The method is based on the interaction of the two groups of indicators. A strong bullish trend may be expected if the following conditions are met:
- The group of short-term MAs crosses all of the long-term MAs from below above;
- The short-term moving averages are aligned in their sequence (the 4 period MA is above the 7 period MA, which is in turn above the 11 period MA and so on);
- The moving averages are close to each other, forming a tight ribbon.
An example can be seen in the following picture:
The 5 short-term moving averages (green) are crossing the long-term moving averages (red) and align in the sequence 4>7>11>14>17. The crossing is followed with a strong uptrend on EUR/USD.
The ribbons can indicate an emerging bearish trend, too. Traders might consider entering a Selling position if the following conditions are fulfilled:
- The short-term moving averages crosses all long-term MAs from above below;
- The short-term indicators are aligned in an opposite sequence: the 17-period MA is above the 14-period MA, which in turn is above the 11-period MA and so on;
- The MAs are located close to each other and form a narrow ribbon.
In the example above it is visible that the short-term MAs crossed the long-term MAs downward and they are aligned in the 17>14>11>7>4 sequence. The reversal is confirmed with a rapid downward trend on EUR/USD.
In periods of market consolidation, the moving average ribbons can get tangled together in one spot, forming a so-called “knot”. A “knot” may signal that a strong trend reversal is upcoming.
However, in such a scenario, traders aren’t sure whether the market will start an upward or downward movement after the sideways trend, so “Buy” and “Sell” orders may be placed above and under the most recent high and low, respectively. Depending on how the “knot” gets resolved, one of the orders will be triggered and a position will be opened.
The set up
In order to set up the Moving Average Ribbon system, only one type of an indicator is required — the Moving Average. You may find it in the indicator menu and set up according to your personal preference and need.
The Moving Average Ribbon can be set up not only with the Simple Moving Average, but with other types of MAs, too. For example, traders may use the Exponential Moving Average, the calculation of which prioritises recent price data.
The MA Ribbon is an interesting tool that gives traders flexibility: they can set it up according to their needs and adjust the amount of moving averages, their period and type. Of course, it is crucial to remember that regardless of the quantity of the indicators, it does not guarantee that the received signals will be 100% accurate.
The moving average remains a lagging indicator, which means that from time to time it may give out wrong information. Ideally, the Moving Average Ribbon should be combined with other types of analysis (for instance, fundamental) and a well thought through money management system.