Moving Average
Crossovers
| Let's talk about the Golden Cross and the Death Cross. No, we're
not opening a deck of cards and telling your fortune. These
colorful terms refer to patterns you probably use every day in
your trading but don't refer to by these names. Along with its
many cousins, they comprise a whole division of technical
analysis. You might know them better as moving average
crossovers. |
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Moving averages emit vital market data, but all of them exhibit
one common limitation: They lag current events. By the time a
20-bar average curves upward to confirm a trend, the move is
already underway and may even be over. While faster incarnations
(such as exponential averages) will speed up signals, all of
them ring the trading bell way too late. |
| Multiple moving averages overcome many flaws of the single
variety. They're especially powerful when used in conjunction
with price patterns. For example, pick out a long-term and a
short-term average. Then watch price action when the averages
turn toward each other and cross over. This event may trigger a
good trading signal, especially when it converges with a key
support or resistance level. |
Averages display all the common characteristics of
support/resistance. For example, one average will often bounce
off another one on a first test, rather than break through right
away. Then, like price bars, the odds shift toward a violation
and crossover on the next test. Alternatively, when one average
can't break through another average after several tries, it sets
off a strong trend-reversal signal.
Different holding periods respond to different average settings.
One-to-three-day swing trades work well with averages that
maintain a 3x to 4x relationship between shorter and longer
periods. This allows convergence/divergence between different
trends to work in the trader's favor.
For example, the daily chart may show a strong uptrend, while
the 60-minute chart begins a deep pullback. A 40-day average
will stay pointed in the trend direction for a long time, but a
13-day average (3x13=39) will turn down quickly, and head
straight for the longer average. The point where they intersect
represents a major support level.
Crossovers mark important shifts in momentum and
support/resistance regardless of holding period. Many traders
can therefore just stick with the major averages and find out
most of what they need to know. The most popular settings draw
charts with a 20-day for the short-term trend, a 50-day for the
intermediate trend and a 200-day for the big picture.
Long-term crossovers carry more weight than short-term events.
The Golden Cross represents a major shift from the bears to the
bulls. It triggers when the 50-day average breaks above the
200-day average. Conversely, the Death Cross restores bear power
when the 50-day falls back beneath the 200-day. The 200-day
average becomes major resistance after the 50-day average drops
below it, and major support after breaking above it. When price
gets trapped between the 50-day and 200-day averages, it can
whipsaw repeatedly between their price extremes. This pinball
action marks a zone of opportunity for swing trades.
Crossovers add horsepower to many types of trading
strategies. But try to limit their use to trending markets.
Moving averages emit false signals during the "negative
feedback" of sideways markets. Keep in mind these common
indicators measure directional momentum. They lose power in
markets with little or no price change.
For years, technicians have tried to filter crossover systems
through trend-recognition formulas in order to reduce whipsaws.
You can try this for yourself, or just look for price patterns
that tell you the crossovers are worthless.
Persistent rangebound markets limit the usefulness of all types
of average information. All moving averages eventually converge
toward a single price level in dead markets. This flatline
behavior yields few clues about market direction. So stop using
averages completely when this happens, and move to oscillators
(such as Stochastics) to predict the next move.
