A type of trading strategy that has been used for some years to trade successfully in the Forex market and with other financial instruments is based on moving averages tunnels such as the Vegas systems. In summary, these are discretionary systems for swing trading which are based on moving averages envelopes. To better understand how works this type of strategy we will explain in detail a system known as Vegas Wealth Builder.
The author of this strategy has defined the following steps for implementation:
1.) Open a daily chart, no matter if it is a bar or candlestick price chart. At this point we must clarify that the tunnel systems can also be used quite effectively in other time frames (major and minor) as 4 hours or 1 hour, for example, depending on the system you are using, however, the method we are explaining here applies especially in a daily time frame.
2.) In this chart put two exponential moving averages (EMA) of 24 and 28 periods. In this case, the assembly formed by these two moving averages is what the Vegas system knows as a tunnel.
3.) Then the envelopes on the EMA of 28 periods are calculated based on the Fibonacci series. In this case, Vegas uses the following numbers: 89, 144, 233, 377, 610, 987. Today there are programs such as Expert Advisors for Metatrader 4 which automatically calculate and draw these envelopes in a chart, but we include this calculation to illustrate how this methodology works.
Thus, if you want to calculate three envelopes then you have to add and subtract to the EMA of 24 periodos the values of 89, 144 and 233 pips. This can be best illustrated by the following example for the EUR/USD assuming an exponential moving average of 24 periods of 1.3720:
- 1.3720 – 0.0233 = 1.3490
- 1.3720 – 0.0144 = 1.3580
- 1.3720 – 0.0089 = 1.363
- 1.3720 + 0.0089 = 1.381
- 1.3720 + 0.0144 = 1.386
- 1.3720 + 0.0233 = 1.395
From its inception, the Vegas system has used a typology for currency pairs, through which it recommends the following envelopes depending on the pair being analyzed:
- EUR/USD: 89, 144, 233 y 377
- GBP/USD: 89, 144, 233, 377 y 610
- USD/CHF: 144, 233 y 377
- USD/JPY: 89, 144 y 233
- AUD/USD: 89, 144 y 233
- USD/CAD: 144, 233 y 377
- EUR/JPY: 144, 233 y 377
- EUR/GBP: 89, 144 y 233
Now, if we apply this approach to other instruments such as the Future of the S&P 500, the envelopes must be calculated as follows:
- 55 (13.75 points).
- 89 (22.25 points).
- 144 (36 points).
- 233 (58.25 points).
- 377 (94.25 points).
With this, we try to illustrate how this methodology can be applied to other instruments and not only to Forex.
4.) (Position opening) Now that we have calculated the envelopes and have drawn these lines on the chart, there will be a signal of a possible entry every time the asset price reaches a certain envelope, especially those indicated below for each instrument in which we trade.
- EUR/USD: 233
- GBP/USD: 233
- USD/CHF: 233
- USD/JPY: 144
- AUD/USD: 144
- USD/CAD: 233
- EUR/JPY: 233
- EUR/GBP: 89
- S&P 500: 89
5.)If we observe the conditions described above in the analyzed chart, the procedure is as follows:
- If the signal occurs under the tunnel, it is recommended to open a long position. On the contrary, if the signal occurs above the tunnel the strategy recommended to open a short position, always remembering that this is a swing trading strategy. Remember at all times that it is not enough that the price reaches or exceeds an envelope, the market must also show clear signs of a change in the trend before considering opening a position.
- The stop loss should be placed at the highest high for short positions or at the lowest low for long positions. Of course, we are talking about the high or low prices that occurred more recently.
- If we open a buy/sale position, the position half should be closed at the precise moment when the asset price reaches the tunnel. At the same time, we move the stop loss to the breakeven point (the point at which, if the market moves against us we will not lose money with our trade) so we have guaranteed a minimum income for the rest of our trade. A useful option is to use a dynamic stop loss (trailing stop) as offered by many trading platforms like Metatrader 4.
- The position half that we still have on the market should remain open until a clear sign that the market may reverse occurs in the opposite envelope lines.
- If we have two losing trades in a row, it is an indication that the market is in a particularly strong trend so it is best not to open any position until the extreme envelope line is reached. If even in this case our trade is unsuccessful, it is best to wait until the price reaches the tunnel again in order to find a new entry point to the market.
- It should finally be noted that like any trading strategy, the key to the success of this system is discipline. There are no perfect systems, so the trader should not panic when losses occur as this is normal and it is part of trading.
Finally, we included the following picture that provides a clearer idea about this system based on moving averages tunnels:
If anyone is interested in learning more about the issue and trying this strategy on the following link you can download various documents produced directly by Vegas where he explains in more detail the system. Also, there is a file for Metatrader 4 which serves to calculate and draw envelopes automatically in any chart of any instrument: