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In the previous article we have discussed how to use the breakout trading method. It has its pros and cons, since traders do not always have the time and patience to monitor the breakouts and can’t always catch the right moment to enter a deal. Traders that do not wish to set support and resistance lines and wait for the breakout, may consider trying the moving average bounce which involves just one indicator to monitor the asset price. 

This approach goes beyond short-term highs and lows to determine the overall direction of a stock. It monitors the “bounces” to find trading opportunities as an asset moves back and forth in the direction of the trend. Using this method, a trader tracks certain activity on the trading chart and then trades the instrument when it moves away from the moving average line, reverses, and then bounces.

Let’s look at it more in depth to understand how it works.

How does the moving average bounce work?

Stock prices naturally fluctuate up and down throughout the day (or over a longer period of time). However, these fluctuations usually remain within a certain range, resulting in an overall upward or downward trend.

The Moving Average bounce works both for long (“Buy”) and short (”Sell”) deals. It uses an exponential moving average that gives more weight to recent price movements, giving a trader the opportunity to track where a stock is moving and time the price jumps when they collide with the moving average line.

Essentially, the method looks for the times when an asset enters a strong trend, but tends to bounce back to the moving average. After bouncing, it continues moving in the original direction. This bounce is used as the guide by the moving average bounce method.

While this method is widely used by many traders, both novice and experienced, it does not give a guarantee of a perfect signal and requires a good grasp of its mechanics and practice. To master this approach, read about how to set it up and apply below.

How to set up the indicator?

This method is based on a specific setting of the exponential MA. Using a moving average eliminates short-term fluctuations in the chart and shows the overall direction and trend of the investment. It ensures that the method can be used on any asset of any instrument, for example, Forex, CFDs Stocks, or CFDs on Cryptocurrency.

In this approach, an exponential MA of the 34 period and candlestick timeframes of 1-5 minutes are used. The short timeframes used may allow traders to repeat this method for several deals during the day, if they choose to.

Trading With The Moving Average Bounce Approach

To set it up, find the Moving Average indicator in the indicator list on the IQ Option platform. Make sure to pick the EMA type and change the period of the indicator to 34. Traders may change the settings of the indicator in accordance to their personal preference and trading plan — the higher the period of the indicator, the smoother the line will be, and vice versa.

How to apply the moving average bounce in trading?

Before going into the details, it is important to highlight that, as with any indicator, divergences may occur and this method may not work 100% correctly every time. This means that having a strong risk management plan (for example, setting stop-loss and take-profit levels) is crucial.

In order to use the moving average bounce method, traders can look for a sequence of signs that may indicate a potential entry signal. 

For a long deal (possible “Buy” indication):

  1. The price chart is trending in an upward direction, moving further away from the exponential moving average. 
  2. The price then reverses, moving down and making lower lows, towards the indicator line and touches it, or plunges slightly below it.
  3. After the following candlestick fails to make a lower low and the price breaks through the indicator upwards, it may be considered a signal for an entry. 

As an example, have a look at the chart below. The chart moves upwards, then reverses and touches the indicator, bouncing back in the same direction. The moment of the bounce could indicate a possible entry for a long deal.

Trading With The Moving Average Bounce Approach
An example of a signal to “Buy”

For a short deal (possible “Sell” indication):

  1. The price chart is trending downwards, moving further down and away from the indicator line.
  2. The chart reverses, making higher highs and touches the moving average, or goes slightly beyond it.
  3. After the following candlestick fails to make a higher high, the price reverses and breaks through the indicator downwards, continuing the downtrend. This may be an indication for an entry.

In the example below the chart shows conditions for a possible short entry, with the chart bouncing off the moving average downwards.

Trading With The Moving Average Bounce Approach
An example of a signal to “Sell”

As it was specified above, the candlestick timeframe used for trades with the moving average bounce is 1 to 5 minutes. This means that the approach is suitable for short-term trades, and may be used in conjunction with other short-term methods (for example, the scalping technique).

The bottom line 

The moving average bounce is a method that is used by traders that prefer working with short timeframes and look for confirmations of the trend. This approach looks at the highs and lows of price action to create an average trend line for price movement and may help traders catch the rebounds against it. Still, as any trading method, it cannot be perceived as 100% accurate, so it has to be accompanied by appropriate risk management tools for better money management. 

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