Depending on market volatile, crossovers can happen frequently which can be seen in the chart before the three crosses over, which is mentioned above. Due to this, many traders will use extra indicators and confirmation before they enter a trade. They will also lag the market due to the delayed nature of the indicator which can lead to trades not being placed at the optimum time.
What you will find is the number of periods included in the MA will also have a great effect on the movement of the line and how close it will stay to the spot rate. The main rule to remember is the few the amount of periods in the MA the close to the spot price it will lay.
Multiple Moving Average Signals – Many traders will opt to use multiple MA using a different amount of periods, one with a greater amount and one with a smaller amount of periods. The MA with fewer data periods will be volatile and will stay closer to the spot price.
Below you can see the same chart above with a blue MA of 25 and a red MA of 10.
Moving Averages are one of the oldest and most well know form of technical analysis. The main benefit of using this indicator is to reduce the noise of the market and the fluctuations which make it difficult to interpret real-time data. Traders using this either seek to find the trend or use moving average crosses to find reversal points in order to time the market buys and sells at the best possible level.
Simple Moving Average SMA – This is the most basic type of moving average. It is calculated by adding up a series of prices over a time period and then dividing by the total number of data points. The formula determines the average of the price and is adjusted each time a new data point is added. When the new data point is added the oldest one is then removed from the calculation which in effect moves the average as each new price is included in the calculation.
Weighted Moving Average WMA - This is calculated in the same manner as the simple moving average but it also includes values that are linearly weighted. This means that the most recent data points are rated higher as they will have a greater impact on the average. In this way you may give the oldest data point a value of 1, then the next 2 and so on all the way to the latest data point. This method is used as many traders find that it is more relevant when trying to determine the trend. The main issue with this method is the average line will end up rougher making it harder to discern a trend from a fluctuation. This can be helped by adding a simple moving average to the chart as well.
Exponential Moving Average EMA – This is similar to the simple moving average but instead of adding the latest data point and then removing the oldest in the calculation you just keep adding each new data point while keeping the oldest so the number of data points increases. To take an example with your initial simple moving average you have 20 data points when the next data point comes out it will then be averaging all 21 data points. Then when the next data point comes out you have 22 and so on.
Interpreting the Signals
Single Moving Average Signals – Signals from an individual moving average will come when the moving average either crosses above price line or crosses below the price line. In the below graph you can see a 20-day moving average attached to the chart in red. There are 3 dots showing the 3 latest signals when the moving average either crosses above or below the price line. On the first dot, you can see the line passes below the price line indicating a buy which would then be closed and reversed by the next signal point when the moving average crosses above the line. The last dot shows where the MA crosses the price line and this is where you would then close out your short trade. Both of these trades would have been profitable.
The moving average with the fewer periods will be the fast MA and when this crosses above the slower one it is considered a buy signal. And with the opposite when the faster moving average moves below the slower moving average it is a sell signal. In the above example, we have only used 2 MA but you can use as many as you would like with multiple different periods select in each.
On the above example you have a GBPCAD chart showing two moving averages at 25 and a 50 day moving average. When the 50 day moving average is above the 25 day moving average the market is trending downwards and at the original cross over of the 50 over the 25 this is the time when you would go short. You would then look to close or reverse the position when the 25 moves back above the 50 indicating a reversal in trend. On the above example the is then another cross over at exatly the same level which indicates the trend changing again and that the trader should resume his short position.
Moving averages can be a great tool for spotting trends but these trends can sometimes playout over a long period of time and end with the some trades not being profitable. The basis of this trading is that your profitable trades overall would be greater than the sum of the losing trades.