Managing Risk & Moving Average Crossovers

I read a few Trading Newsletters, not many, but a few that have relevant and interesting pieces in them.  I recently read one of the articles in Van Tharp’s newsletters written about Chuck Le Beau and his trading story.  He’s talking about his experiences working for a broker and working with one of their best Traders, a chap by the name of Dave Johnson.

I picked out a couple of paragraphs that dealt with Risk Management and Moving Average Crossover strategies. 

“As this program started out, Dave called one profitable trade after another—five straight winners in a row.  The 6th trade, however, lost some money.   When Dave put out the 7th trade information, practically nobody in the program took it.  Why?  Hutton discovered that nearly everyone in the program had been putting their entire account into each position and the last trade had wiped out a lot of them. 

After that experience, Johnson started giving lectures at Hutton about risking only a small percentage of your equity on any one trade.   Chuck says, in retrospect, that this was his first exposure to position sizing strategies.”

I find that interesting to read how amateurs are always thinking of how much money they can make whereas professionals are always thinking of how much they can lose.  It did not surprise me to read that all the amateurs had maxed out their accounts with their positions.

“In 1987 there were no platforms for trading research so David wrote the programs to test Chuck’s idea.  They first tested moving average crossover combinations—about 26,000 pairs each night until they had tested well over a million combinations. Their conclusion?  During trends, many combinations worked well, but all of them gave back their profits during sideways markets. This led David and Chuck to work on how to identify and measure trends.”

So they tested over a million combinations at the rate of 26,000 pairs each night!  That’s quite some grunt work they’ve put in and it would be hard to argue against their findings based on their pain-staking research. 

Yet people love Moving Average Cross-over strategies and there are people out there selling them by the dozen.  Why?  I’m not sure really, perhaps it’s an element of the simple visual clue of a cross-over.  Or maybe the fact that it requires no real work!?  You always see shots of absolutely beautiful trending opportunities in the sales & marketing literature………never the messy sideways market where it whip-saws back and forth! As their research and my own personal experience  pointed out they work beautifully during trends but you ultimately give it all back during range-bound markets.

Whilst I do use moving averages and keep an eye out for where they are in relation to each other I’ve never been any good at trading just a pure MA cross-over. Many years ago one of my Mentors asked me to trade Moving Average Crossovers on an account for him.  I really struggled with it and was ultimately unsuccessful. Where do you buy?  Exactly when they cross? At the close or open of the crossing bar?  When it breaks the recent high or low?  When it re-tests the cross-over, on the odd occasion that it does?

I admit that I do  have one trend following strategy that uses a Moving Average Crossover the actual cross is only one of 4 elements that all have to be in place for me to take a trade. I would not be looking to or advise anyone else to trade just pure Moving Average Crossovers.

Until next time, trade well.

FXTrader Paul

P.S. How much stick will I now receive from traders and strategy sellers telling me how wonderful pure MA Cross-overs are?