Traders use moving averages (MA) to gain a concise idea of the price movement. They can be used as the main analytic tool or just to back up a trading decision. But since the MAs are lagging pointers, crossovers are used by traders to strengthen their decision.
With MA crossovers, you get a candid trading signal with sufficient inputs on resistance and support range irrespective of how long the trade is held. The approach is also ideal for spotting a trend’s middle phase. We will see the different types and how you can practice them for reaping huge profits.
Two types of moving average crossovers
Of the various MAs, two types are more prevalently in use than the rest. These include long and short-term moving averages.
- Long-term moving averages
An extended period of 50 or more days makes this type a slow-moving one. A crucial factor to note here is the less reaction to the price action over the short term when associated with the brief-term type. Furthermore, you get fewer signals here, which makes them more significant. But, the slow movement can make the signals more lagging than the rest.
- Short-term moving averages
As the name implies, this type has a shorter span, such as 5, 10, etc. The short span makes it an active indicator of the price action. The frequency of signals is more, which makes them more significant, but there is the hazard of more false signals.
Of the two types above, the shorter and reactive average is vital as it can give a precise market movement. Both of them are utilized best in a market that is trending and where the possibility of sideways trade is present.
Short timeframe crossover signals
With a shorter time, the information provided by the moving average is very sensitive. The advantages include closer tracking of the price action and a superior number of trades.
The drawback of this signal is there are more false indicators. And, since it is more sensitive, the strategy does not work effectively in sideways trade. But, the timelier signal makes up for the lack of effectiveness.
To succeed with this strategy, you need to identify the consolidation and trending segment. For confirming whether you are inside or exiting a consolidation part, the price movement is the identifying factor. You can spot the troughs and peaks here instead of the lows that you notice in a downward movement.
Linking the price action with short timeframe crossover signals results in better accuracy and a lower possibility of false signals.
Golden cross and death cross
When compared to the short-span crossovers, the longer span ones are more crucial, which is why the following two methods are considered necessary by traders.
A golden cross is a term that denotes a marked change in the market sentiment where bulls remain dominant. This happens when the moving average of a medium-term such as a 50-day mean crosses a long term one such as a 200-day average.
Death cross denotes a change where the bears are dominant. Here the medium span average crosses below the 200-day MA.
What do the two moves signify for a trader?
When broken, a huge resistance level is reached by the 200-day moving average, following a drop-down of the medium span average and an upward penetration occurring in the wake of a support level.
So, it is common to see the price movement being restricted between the long term and medium averages shifting constantly flanked by the extreme prices here. Swing trade possibilities are more in this situation.
Three moving average strategy
Although there are several different crossover methods used by traders, they are not equal in the results they produce. There are alternate averages that can have a more potent impact, like the EMA (Exponential Moving Average).
This average provides a better interpretation of recently formed candles when compared to the older ones. As a result, the signal formed is more dynamic and sensitive than the other averages seen above.
Thus, a trader should use multiple averages for effective results. The three averages strategy becomes important in this context. A good combination of long, short, and exponential averages is ideal. When the market is trending, the means are aligned such that you can find the shorter one near the price action, and the furthest located is the longer MA.
It is possible to employ other combinations as well, as indicating the consolidation phase and use the EMA, which utilizes long and short MA elements. Adding price movement here makes the method impactful.
What to be aware of when utilizing moving averages?
It is common for traders to practice crossover MAs for confirmation. But, there are two things that you have to remember. Firstly, understand that these are lagging, and secondly, they belong to the trending gauge category for measuring the moment of price action.
In the case of ranging markets, the means are not significant as they end up being at a fixed spot of price. This is particularly true when you sight the price action as a flat and thin line. In these circumstances, it is hard to identify the market direction easily. Further, the MAs also tend to create false signs in a market that is ranging.
So, the best way to utilize the benefits of these strategies is to restrict using these methods as a foundation for making decisions in a trending market. Also termed sideways trading, this entails keeping the averages out of the picture and using indicators such as RSI, Stochastic, and other such oscillators.
In conclusion, the crossovers are finest when employed for making exits and entries. They can also spot resistance and support potential. However, the MAs are formed from historical information and merely give the mean price during a specific span.
Further, you have to counter the occurrences of multiple false signals. Using an additional indicator, like Bollinger, can help identify a better range rather than using just the MAs for assessing trends. This makes the trading method more impactful and less frequent.