The moving average (MA) is one of the most popular technical analysis indicators traders use to find trading opportunities. A moving average strategy involves calculating the average price of an asset over a certain period and using it as a basis for making trading decisions.
The moving average calculation takes the close of each bar and then divides the total by the number of bars. The moving average is then plotted on a chart as a line that shows the average price over time. The most commonly used periods are 10, 50, and 200 days. However, the moving average can be used on any chart length from 1 minute to 1 month.
The most popular moving average is a simple moving average (SMA), where each price is given equal weighting. However, an exponential moving average (EMA) and weighted moving average (WMA) give more weight to recent prices, making them more responsive to price trends. I prefer to use a simple moving average as I can use it to forecast other traders' orders.
Five popular moving average strategies
Moving Average Crossover Strategy
This strategy involves buying when the price crosses above a downward-pointing moving average and selling when it crosses below an upward-pointing moving average. This trend reversal strategy is most successful at the end of an extended price move higher or lower.
In an uptrend, the moving average will act as support and push prices higher. Should prices fall below the upward-sloping moving average, a selling opportunity exists as the chances of further price falls are high. Conversely, a buying opportunity exists in a downtrend when the market rises above a downward-pointing moving average.
- Regular trading opportunities
- Easy to understand
- Can lead to significant losses if traders do not use a stop-loss order
Moving Average Support/Resistance Strategy
When the market is in a strong trend, the moving average will act as a support level in an uptrend and resistance in a downtrend. So in an uptrend, should prices touch the moving average and rise, there is a buying opportunity. On the other hand, there is a selling opportunity when prices touch the downward pointing average and fall.
- High-risk reward trading opportunities
- Often, the market gets close to the moving average but does not touch before rising
- Volatility rises close to the moving average, so hard to enter a position
Moving Average Second Cross Strategy
Should prices fall below the moving average in an uptrend and then cross back above the moving average, there is a high probability the market will rise significantly again. This strategy is powerful as the traders who just sold on a break below the moving average will be joined by trend traders entering long positions. This strategy also works in a downtrend when the prices fall below the moving average for the second time.
- Can lead to significant profits
- Only a small stop loss is required
- Only works when the trend is strong
Moving Average Gap Strategy
When prices move significantly above or below the moving average, there is a high probability the market will move back toward the moving average. This is because traders calculate the number of pips above and below the moving average based on historical data, which usually results in a reversal move. For instance, a day trader might sell if the USDJPY rises 10 pips above the 10-bar moving average of a 5-minute chart.
- Regular profitable trading opportunities
- Difficult to determine the amount of gap required
- Large losses possible in trending markets
Golden Cross and Death Cross
The golden cross and death cross are important signals generated by moving averages. This strategy involves using two moving averages of different lengths to find changes in the trend. This strategy works best when the market is in strong trends and for traders looking for significant trend moves.
The golden cross occurs when the 50-day moving average crosses above the 200-day moving average, indicating a bullish trend. Conversely, the death cross occurs when the 50-day moving average crosses below the 200-day moving average, indicating a bearish trend. The 50-day and 200-day combination is popular, but traders also use other varieties, like 10 days and 30 days.
- Clear entry points
- Can lead to significant profits in trending markets
- Few trading opportunities
- Poor performance in range trading market
In conclusion, moving averages are a valuable tool for traders to identify trends in the market and make trading decisions. Moving average strategies can help traders capture trends and determine overbought and oversold levels.