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Moving Average Crossover System

A moving average crossover system uses two moving averages, a shorter-term and longer-term average, to generate trading signals. The shorter-term average responds more quickly to price changes while the longer-term average responds more slowly. Traders buy when the shorter-term average crosses above the longer-term average, indicating an upward trend, and sell when it crosses below, indicating a downward trend. This system generates fewer signals than a single moving average system, reducing trades in sideways markets, but signals that do occur have a higher probability of profitability. Popular moving average combinations include 9-day and 21-day EMAs for short-term trades, 25-day and 50-day EMAs for medium-term

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paolo
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805 views3 pages

Moving Average Crossover System

A moving average crossover system uses two moving averages, a shorter-term and longer-term average, to generate trading signals. The shorter-term average responds more quickly to price changes while the longer-term average responds more slowly. Traders buy when the shorter-term average crosses above the longer-term average, indicating an upward trend, and sell when it crosses below, indicating a downward trend. This system generates fewer signals than a single moving average system, reducing trades in sideways markets, but signals that do occur have a higher probability of profitability. Popular moving average combinations include 9-day and 21-day EMAs for short-term trades, 25-day and 50-day EMAs for medium-term

Uploaded by

paolo
Copyright
© © All Rights Reserved
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Moving average crossover system

As its evident now the problem with the plain vanilla moving average system is that it
generates far too many trading signals in a sideway market. A moving average
crossover system is an improvisation over the plain vanilla moving average system. It
helps the trader to take fewer trades in a sideways market.

In a MA crossover system, instead of the usual single moving average, the trader
combines two moving averages. This is usually referred to as ‘smoothing’.

A typical example of this would be to combine a 50 day EMA, with a 100 day EMA.
The shorter moving average (50 days in this case) is also referred to as the faster
moving average. The longer moving average (100 days moving average) is referred
to as the slower moving average.

The shorter moving average takes lesser number of data points to calculate the
average and hence it tends to stick closer to the current market price, and therefore
reacts more quickly. A longer moving average takes more number of data points to
calculate the average and hence it tends to stay away from the current market price.
Hence the reactions are slower.

Here is the chart of Bank of Baroda, showing you how the two moving averages
stack up when loaded on a chart.As you can see, the black 50 day EMA line is closer
to the current market price (as it reacts faster) when compared to the pink 100 day
EMA (as its reacts slower).

Traders have modified the plain vanilla MA system with the crossover system to
smoothen out the entry and exit points. In the process, the trader gets far fewer
signals, but the chances of the trade being profitable are quite high.

The entry and exit rules for the crossover system is as stated below:

Rule 1) – Buy (fresh long) when the short term moving averages turns greater than
the long term moving average. Stay in the trade as long as this condition is satisfied

Rule 2) – Exit the long position (square off) when the short term moving average
turns lesser than the longer term moving average

Let us apply the MA crossover system to the same BPCL example that we looked at.
For ease of comparison, I have reproduced the BPCL’s chart with a single 50 day
MA.
Notice, when the markets were moving sideways, MA suggested at least 3 trading
signals. However the 4th trade was the winner which resulted in 67% profit.

A trader can use any combination to create a MA cross over system. Some of the
popular combinations for a swing trader would be:

a. 9 day EMA with 21 day EMA – use this for short term trades ( upto few
trading session)
b. 25 day EMA with 50 day EMA – use this to identify medium term trade (upto
few weeks)
c. 50 day EMA with 100 Day EMA – use this to identify trades that lasts upto
few months
d. 100 day EMA with 200 day EMA – use this to identify long term trades
(investment opportunities), some of them can even last for over a year or more.

Remember, longer the time frame the lesser the number of trading signals.

Needless to say, the MA crossover system can also be applied for intraday trading.
For instance one could use the 15 x 30 minutes crossover to identify intraday
opportunities. A more aggressive trader could use 5 x 10 minute crossover.

You may have heard this popular saying in the markets – “The trend is you friend”.
Well, the moving averages help you identify this friend.

Remember, MA is a trend following system – as long as there is a trend, the moving


averages works brilliantly. It does not matter which time frame you use or which
cross over combination you use.

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