As promised, we will now explore some simple trading systems using the two other types of moving averages we have discussed… the weighted moving average (WMA) and the exponential moving average (EMA).
As we previously discussed, both the WMA and the EMA give more “weight” or value to the most recent prices. This appeals to many traders as they believe that the most recent prices should be given more consideration than the earlier prices. In essence, we could say that those traders are simply looking to make their moving averages more responsive to current market movements.
If the WMA and the EMA are more responsive to current market movements could we assume that trading systems built with a WMA or an EMA would perform better? In order to answer that question let’s take a look at how the WMA and the EMA performed using the same data we used when optimizing the SMA.
We will use the same basic system that we used for our SMA, except we will be trading using the WMA and EMA. First, we will optimize the WMA and EMA trading systems to see which moving average length (number of periods) yielded the highest total net profit. For the WMA and the EMA, as we did with the SMA, we varied the moving averages length from 1 to 100 days.
For the WMA the 61-day WMA yielded the highest total net profit.
Here is the first rule of our 61-day WMA trading system:
Buy Rule: When the EURUSD closes above the 61-day WMA we will buy (go long) the EURUSD at the next open
Then we will create a simple rule to signal when to sell (go short/sell short) the EURUSD.
Here is the second rule of our 61-day WMA trading system:
Sell Rule: When the EURUSD closes below the 61-day WMA we will sell short (go short) the EURUSD at the next open
Now we have a basic 61-day WMA trading system. Here’s a chart showing us the trades for our simple system thus far.
Figure 1.10
Figure 1.10 shows us some of the trades for our 61-day WMA. The blue up arrows point to the bars where we bought on the open. The red down arrows point to the bars where we sold on the open. Let’s take a closer look at our trades.
Figure 1.11
Figure 1.11 shows us our daily EURUSD chart with a closer look at our last 4 trades. Here is how the 61-day WMA system performed.
61-day WMA system
Total Net Profit = $22,781.20
Trading Period = 12/28/2009 – 8/3/2015
Now we will take a look at an EMA system.
For the EMA the 42-day EMA yielded the highest total net profit.
Here is the first rule of our 42-day EMA trading system:
Buy Rule: When the EURUSD closes above the 42-day EMA we will buy (go long) the EURUSD at the next open
Then we will create a simple rule to signal when to sell (go short/sell short) the EURUSD.
Here is the second rule of our 42-day EMA trading system:
Sell Rule: When the EURUSD closes below the 42-day EMA we will sell short (go short) the EURUSD at the next open
Now we have a basic 42-day EMA trading system. Here’s a chart showing us the trades for our simple system thus far.
Figure 1.12
Figure 1.12 shows us some of the trades for our 42-day EMA.
Figure 1.13
In Figure 1.13 shows us our daily EURUSD chart with a closer look at our last 5 trades. Here is how the 42-day EMA system performed.
42-day EMA system
Total Net Profit = $24,396.90
Trading Period = 12/28/2009 – 8/3/2015
| 27-day SMA system Total Net Profit |
61-day WMA system Total Net Profit |
42-day EMA system Total Net Profit |
| $32,855.20 | $22,781.20 | $24,396.90 |
Table 1.3
Looking at our results we can see that they may not be what some traders would expect. That is because those traders were assuming that the WMA and the EMA were more responsive to recent market movements and thus should yield better results. As you can see from our comparison the SMA displayed the best performance in terms of total net profit.
One of the greatest benefits of technical analysis is that we can test and evaluate rather than guess and assume. Please keep in mind that the simple optimizations we performed were by no means comprehensive. In fact, we are comparing the performance of our optimized SMA, WMA, and EMA based on a single measure of performance. That measure of performance is the total net profit.
Next, we will explore more trading systems using moving averages.
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