Mastering Moving Average Crossover Secrets Can Be Highly Profitable
Monday, March 22nd, 2010
Moving averages are one of the simplest and the most popular technical indicators that can be used in any market. While using averages, the length of time used to calculate them is very important. Moving averages with shorter time periods fluctuate more activley and tend to give more trading signals. Shorter time period moving averages tend to whipsaw a lot that can cause losses.
There are three types of moving averages. Simple averages are calculated by dividing all the prices with the number of time periods used to calculate the average. In case of weighted and exponential moving averages, more weight is given to the recent prices as compared to the old ones making them more responsive to recent price action as compared to the simple moving averages.
Traders use a combination of slow and fast averages in trading. A trading signal is generated when the two cross each other and hence the name crossovers. Now, longer time period averages tend to move slowly and have a long curve that makes them slow in giving trading signals.
Most traders use the combination of three averages. When the short period average crosses the medium one, this gives a trading signal but this need to be confirmed. Confirmation is obtained when the short and the medium move above the longer period average. Futures traders use the combination like 4,9 and 18 period averages. Stock traders use longer periods like the 40 day, 100 day and 200 day to generate trading signals.
When using moving average crossovers as a technical indicator, you should be long when the short average is above the longer period average. And when it is below, you should be short.
These crossovers between the three averages are an indication the momentum is shifting from one direction to another. Moving Average Convergence Divergence (MACD) is based on these averages and is a powerful technical indicator in the trading arsenal of any trader.
One important caveat about these averages that you need to always keep in mind is that moving averages are lagging indicators and do not work well in choppy or non trending markets. However, in trend markets, they work very well. You need to master them if you want a winning edge in trading!
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