Moving averages are simple but can be a very powerful technical analysis indicator when used in the right way. The moving average indicator is a staple in every trader’s toolbox and comes in a few varieties: simple, exponential, smoothed, weighted and others.
Forex traders don’t just use moving averages; it’s an important tool used by financial market analysts. For example, the notorious death cross that all stock market pundits fear. When the 50-day moving average crosses over the 200-day moving average, it’s a bearish signal.
That’s just one way to use moving average crossovers to indicate potential trade ideas. But forex traders need something far more dynamic than the death cross. Because of how simplistic moving averages are, there are infinite trading strategies based on moving average crossovers.
Many believe that moving averages are only helpful for assessing trend direction or finding take-profit and stop-loss levels; they can generate buy and sell signals. This article explores some of the most popular moving average crossover trading strategies and will help you find what’s best for your trading objectives.
Fundamentals of moving average crossover strategy
A moving average (MA) crossover strategy consists of two or more MA indicators, each with different period lengths. For example, a 20-period moving average and a 50-period moving average.
A buy signal is indicated when the shorter 20-period MA crosses above the longer 50-period MA. A sell signal is indicated when the shorter 20-period MA crosses below the longer 50-period MA.
Typically, a stop-and-reverse method is used when following a moving average trading strategy. Meaning an exit signal is also an entry signal in the opposite direction. In the image below, you can see the up-arrows indicating buy signals and the down-arrows indicating sell signals.
Moving average crossover strategy variations
There are numerous variations to the moving average crossover strategy. There are many different settings and approaches that can be adjusted to achieve different results.
Long-only or short-only strategy
The drawback of following a stop-and-reverse crossover strategy is that you’re always in a position and therefore exposed to risk. Some traders adopt a long-only or short-only approach to following crossovers to limit the number of positions they enter. Whether you’re following long or short signals can alternate based on other indicators, such as a much longer MA.
For example, we’ve added a 200-period MA to indicate the long-term trend in the image below. As the 200-period MA is sloping upward, it indicates a bullish trend. Therefore, we ignore crossovers indicating a short entry.
Secondary indicators for exiting positions
Another drawback of following a stop-and-reverse crossover strategy is that you’re always late to exit your positions. As moving averages are lagging, they may indicate exiting too late, causing you to leave money on the table. This scenario is perfectly highlighted in the image below.
Instead of waiting for crossover signals to close positions, many traders use fixed profit targets, trailing stop losses, risk-to-ward ratios, support and resistance levels, and other indicators.
Points to consider about moving average crossover strategies
Before you fully commit to a moving average crossover trading strategy, you should keep in mind that they only perform well when the market is trending. Most of the time, markets are consolidating, meaning there is no clear trend. Firstly, you need to confirm if the market is trending before a moving average crossover strategy is viable.
While using a moving average crossover strategy, don’t just look at the small timeframe, but also think about the big picture too. If the timeframe you’re trading is too low, standard retracements will give false signals. Moving average crossover strategies are best used on higher time frames, at least 15-minutes or higher.
Another point to remember is that moving averages are lagging indicators and react slowly to market changes; they follow price, they do not predict price. If there is a big price movement in the most recent candle, the moving average might not react because its value is averaged by several other candles. Although the EMA is faster to react to recent price changes, they still lag.
Some traders instinctively try to solve this by shortening the length of their moving averages. While this technique increases responsiveness to the most recent prices, increased sensitivity leads to more false signals. Because of this, relying on moving average crossovers to get entry and exit signals can be inefficient. Many traders only use crossovers for getting high probability entries but use other methods for exiting.
All of the moving average crossover strategies can be applied to different currency pairs, asset classes and timeframes. You can also optimise the periods used in the moving average calculations to refine your strategy even more. Remember, the strategies you read about online aren’t set in stone and can be adapted for your personal style.
Whether you use moving average crossovers or another strategy, it is worth checking out our Winning Trading Systems list here.
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