When we think about trading, it sounds simple and easy. All we need to do is to enter trades, watch them play out, and make bank. But, if you’re a beginner, trading can be intimidating and hard to learn, particularly with all the technical analysis that goes into trading.
When analyzing price charts, it’s often difficult to cut through all the noise and spot volatility or price trends. Moving averages are a popular indicator among traders that allows them to quickly and easily identify critical information regarding the price action of various securities.
Here’s a brief overview of moving averages and ways you can leverage various moving average crossover strategies to trade successfully.
- Moving averages get commonly used in many trading strategies. Two popular types of moving averages are the simple moving average (SMA) and exponential moving average (EMA).
- A moving average crossover occurs when two different moving average lines, such as a 50 MA and a 200 MA, cross over each other.
- The moving average crossover strategy gets commonly used to identify trends and momentum.
- Commonly used crossover strategies include (1) the golden cross, (2) the death cross, (3) the triple EMA crossover strategy, and (4) the 9- and 20-period MA.
What is a Moving Average?
A moving average (MA) is a commonly used technical indicator in many trading strategies. However, because they can easily be measured and applied to different trading and investing strategies, MAs are a solid foundation for both technical and fundamental analysis.
Moving averages are lagging indicators that follow trends based on past prices. They help smooth out price action over time by getting rid of all the noise from price fluctuations. Typical use cases are to identify the direction of price movements and to determine support and resistance levels.
A basic moving average calculates the average closing price of a security over a set number of days. For example, to calculate the 5-day moving average of shares of Apple stock, you would add up the closing price of the stock on each of the past five days and then divide by five. When plotted on a chart, the moving average appears as a line that follows price action.
Note that there are several ways to construct moving averages, and they can get used for any timeframe. While traders typically use the daily closing prices to calculate MAs, they can also use price intervals by the minute or week.
There are two main types of moving averages:
Simple Moving Average (SMA)
Simple moving averages work just like the way we explained above. You calculate an SMA by placing equal weight to each day’s closing price within a defined period.
The main difference between simple moving averages and exponential moving averages is the weight given towards specific points in time. SMAs do not weigh any particular points in time more, whereas EMAs place a greater emphasis on recent price action.
Exponential Moving Averages (EMA)
If we look back to the 5-day moving average example, yesterday’s closing price impacts the EMA more than the closing price from five days ago. As we mentioned earlier, moving averages are lagging indicators, so traders often prefer using exponential moving averages over simple moving averages.
While you can use moving averages on their own, they are not foolproof indicators. Traders often use them alongside other technical indicators, such as moving average crossovers, VWAP, RSI, etc., to make the most out of them.
What is a Moving Average Crossover?
When two different moving average lines cross over each other, a moving average crossover has occurred. For example, when the 50 MA line crosses above or below the 200 MA line, that is a moving average crossover.
While you can get a lot of information from a single moving average, looking at two different MAs can give you additional insights, such as identifying exit or entry points.
Three questions that can get answered by using a moving average crossover system includes:
- Is the price action trending in a specific direction (if at all)?
- Is there a potential entry or exit point?
- Is the trend ending or reversing?
Why Do Moving Average Crossovers Matter?
While moving average crossovers will not always capture exact tops and bottoms, they can help you identify when a trend might be emerging or ending. That allows you to find potential entry and exit points, which you can then confirm using support and resistance levels.
Traders often closely watch moving average crossovers because they can show changes in the momentum or direction of a security’s price. For example, when a 10 MA of a stock’s price crosses above a 50 MA from below it, a trader can interpret that as a signal of the price gaining momentum or experiencing a reversal. Vice versa, if the 10 MA crosses below it from above, that could indicate bearish movement.
How Do You Use Moving Average Crossovers?
To use moving average crossovers, add a couple of moving averages on your chart and wait for them to cross each other. When they cross over each other, you can interpret the crossover as a signal of a trend changing and find a good entry point from there.
Using moving average crossovers as an indicator in volatile environments can work well, but they are less relevant when the price is ranging. That is because you may end up getting too many crossover signals and get stopped out of trades before catching a trend.
Popular Types of Moving Average Crossovers
You may have heard of the golden cross get mentioned recently in reference to Bitcoin or other cryptocurrencies. In simple terms, the Golden Cross involves a shorter-term MA crossing above a longer-term MA. For example, many traders commonly use the 200 MA and the 50 MA golden cross rule. When the 50 MA crosses above the 200 MA, that is a buy signal or golden cross. It is a bullish reversal pattern that indicates the trend is shifting upwards.
This strategy is great for swing trading and identifying trends to trade. However, there are limitations. You should use the golden cross as a framework for defining a big-picture trend and deciding whether to go long or short rather than for identifying when to enter a trade.
A death cross is the opposite of a golden cross and involves a shorter-term MA crossing below a longer-term MA. Going back to the 200 MA and 50 MA strategy, when the 50 MA crosses below the 200 MA, that is a sell signal or death cross. It is a bearish reversal pattern that indicates the trend is shifting downwards.
Triple EMA Crossover Strategy
The triple EMA crossover strategy is a simple and easy strategy that you can use for any financial market and on any timeframe. To use the triple EMA crossover strategy, add three EMA’s to your chart. The EMA with the longest timeframe acts as a longer-term MA, the EMA in the middle is the control, and the EMA with the shortest timeframe acts as a faster-acting MA.
In our example above, we use the 10, 21, and 50 EMAs. The key here is to see where and how the three EMA’s cross. If the 10 EMA moves below the 21 EMA, this could indicate that the price is likely to move lower. If both the 10 and 21 EMA’s move below the 50 EMA, then it’s highly likely the price will move lower. That would be a good time to look for an exit or short the security as it moves lower.
The 4-, 9-, and 18-period EMAs are another popular option if you are interested in using the triple EMA crossover strategy.
9 and 20 EMA Crossover
To find short-term trend reversals, add the 9 and 20 EMAs to one-minute and five-minute time charts. Day traders often use the 9 and 20 EMA crossover to identify where the price of a security’s direction is moving and when to set entry and exit points. For more about day traders click here.
When the 9 EMA crosses over the 20 EMA, that is a bullish indicator of the price continuing to rise. If the price stays above the 9 EMA on the one-minute time chart, it’s a signal to hold your position. If the price falls below the 9, but both EMAs are still bullish and haven’t crossed yet, make sure to watch the five-minute time chart. If the price stays above the 9 on the five-minute chart, you can determine whether to hold your position or exit then.
When the 20 EMA crosses over the 9 EMA, that is a bearish indicator of the price continuing to fall. If you see this crossover, you should either exit your position or short the security.
After testing this method, you may notice that the 9 and 20 EMA crossover happens quite often. If you are doing intraday trading, this is a great tool to incorporate into your strategy.
Using Moving Average Crossovers in Practice
As a long-term investor, I primarily use fundamental analysis to determine whether a security is worth buying or not. However, I often use the 50 and 200 MAs to identify the overall trends for the specific securities I am looking at before taking a long position or adding to an existing one.
For example, in the chart above, we can see that Crowdstrike has been trending upwards since June 2021 – the point where the 50 MA crossed above the 200 MA. This upwards momentum validates my bullish sentiment on the future of Crowdstrike and the cybersecurity industry as a whole. So, I’ve slowly been adding to my existing position with the assumption that the stock’s uptrend is likely to continue.
Looking at Teladoc Health, we can see that the price has been freefalling since March 2021. If we only look at the MAs, it’s easy to exit any long positions or short the stock. However, I still hold shares and have been averaging down over the past few months. In my opinion, the fundamentals of the company and the virtual healthcare industry haven’t changed. I believe that virtual medical visits will get normalized in the future as people realize the benefits of remote medical care. In fact, the stock may likely be oversold.
While the concept of moving average crossovers itself is simple, it can take some time to find which moving averages work best for your trading or investing strategy. Take some time to test out some of the examples we’ve laid out and throw in a few of your own into the mix as well.