Here is what most market gurus are teaching you about moving averages. You take a short-term moving average and a long-term moving average and you buy and sell when you see crossovers. Nice, so you buy here, the price rallies, you exit here with 100% profit, you sell here, another winning trade, one more buy, another win…this is too easy, like printing money.
What they don’t tell you is that these results happen maybe 10%-15% of trading days, if you’re lucky. Here is how the normal trading day looks like. Not so profitable anymore, right, with all the choppiness and false signals? If you follow a crossover pattern, in 2 weeks your account is gone, guaranteed.
If i learned something in my over 10 years’ experience of trading is that moving average crossovers don’t work like advertised.
So in the following minutes, we’ll talk about moving averages, how you should use them correctly and I’ll show you how i use the crossovers in my trading plan. Before we continue, if you’re new to our channel, make sure you subscribe, click the notifications bell and leave a like to show your support.
Why are moving average crossovers so popular?
Because, a moving average is a trend indicator, and you were told that the trend is your friend, so why not using 2 or 3 moving averages, to increase your chances. Here is a hard truth and, please keep in mind that this is simply my discovery after 10 years of trading.
“Moving averages crossovers don’t work on lower time frames. Period.” – Reza Abbaszadeh
I’ve tested hundreds, thousands of combinations. Some of them were decent, some of them damaged my account. You’ll have a hard time trading crossovers on the 5-minute or 15-minutes charts. If you found a magic crossover that works on lower timeframes, go ahead and share it with me, because i simply wasn’t able to record consistent profit by trading crossovers on lower time frames.
On higher time frames, well, we have another story here, and you might be able to profit from crossovers. But first, let me explain why is dangerous for you to trade crossovers on lower time frames and why this strategy will most likely lead to frustrations and bad results.
Why can’t we use moving averages in lower time frames?
- The biggest drawbacks of moving averages is the fact they lag price. Price moves first and the moving average moves second. You are always behind the price. The moving average is a trend following indicator. It can only tell you when the trend has already happened. You can’t forecast a new trend with a moving average because it’s a lagging indicator. Pay attention in this chart that the moving average was still rising whilst price hit the resistance level and went down by a considerable amount.
- The second problem with moving averages is the noise. One of the best things about using moving averages for trading is that they are designed to smooth out the erratic price data so that you can be able to detect and stay with the trend. However, even the best moving averages suffer from noise. On lower time frames, you will witness many false signals if the market is consolidating or the price spikes up and down due to higher
- Another drawback of a moving average crossover system is the sideways markets. Nothing is more frustrating than trying to use a crossover strategy in a sideways market! Your stop losses won’t stand a chance! Regardless of what type of moving average you use in a sideways market, they will not work effectively.So, if you are a day trader, I would say is better to avoid crossover strategies on lower time frames.
There are better ways to use a moving average.
Moving averages are great to determine the trend direction of your instrument. While price action and structure should be your main focus, you can get a general idea of the market direction with a moving average. So, here is how you could take advantage of a moving average:
How to effecttively use moving averages?
First, to identify and confirm market trend While keeping in mind that are lagging indicators, you can use the slope of the moving average: up sloping is an uptrend and down sloping is downtrend.You can also use price location: if price above moving average, look for long trades. Below the average you would look for short opportunities.
In other words, a stock is considered to be in an uptrend when the price is above a moving average and the MA’s slope is upward and a tock is considered to be in a downtrend when the price is below a moving average and the MA’s slope is downward.
Second, to use them as support and resistance level. Moving averages offer traders dynamic areas of support and resistance because are changing depending on recent price action. Being so common and followed by so many traders, you can often see on charts that the popular moving averages work excellent as support and resistance levels.
A simple MA could be considered as a dynamic area of support or resistance The area between two moving averages could also be considered as a dynamic area of support or resistance. A longer-term moving average like ma 200 has a greater relevance to the price, and offers less false signals, compared to shorter-term
moving averages. Now, let’s come back to the crossovers.
So a moving average crossover system will catch good movements when markets are trending. However, when markets are trading in a range, this system is subject to many losing trades. And on lower timeframes, the odds are not in your favor.
Are moving average crossovers useless?
Well, not quite. On higher timeframes, for traders and investors that hold positions for several months using higher time frames like daily, weekly, or even monthly charts, the moving averages have higher chances of indicating a valid signal. But there’s another problem here.
A two-moving average crossover system is usually a “stop and-reverse” strategy, meaning that you will be in the market at all times when used as a mechanical strategy. Once an entry is triggered, you will remain in the market until the opposite signal is generated, at which time your current position will be liquidated and a new one entered in the direction of the new signal.
But even on higher time frames, this strategy is risky. So, i would only take long positions and completely ignore short signals.
here’s another important tip which will cut your losses even more. When a buy signal is generated, you must wait for the bar to be completely finished before entering the trade. I can’t remember how many times I traded a crossover signal without waiting for the candle to be closed. So, wait for the candle to close and confirm the crossover, it will save you a lot of bad entries. Once you have triggered your entry, there are several ways to manage this trade.
Traditionally, you would remain in the trade until an opposite signal appears. While waiting for an opposite signal to exit your position may be the “normal” approach, you may find this method to be inconsistent, depending on the market’s behavior.
This approach will often lead to extremely late exits, which can severely cut into your profits. Instead, you could try other tactics like using a traditional trailing stop, using a single moving average crossover exit, using a fixed profit target, using Fibonacci extensions as targets or using visual support and resistance levels as targets.
I personally use the 200 EMA and the 20 EMA on the daily chart to search for buy entries on stocks with good fundamentals, but these 2 moving averages are not set in stone. Depending on the stock traded, you can have other values for your crossover signals in a daily timeframe. As you may know, the market will change over time.
At times, a market may be quiet and trending, while other times it may be erratic and directionless, so you should adjust the moving averages of your crossover system to find the best fit. So, no shortcuts here, there is no universal moving average crossover that works on any market.
You must continually back test and adjust your moving averages by yourself. With today’s trading platforms, you can even scan the entire market of stocks with specific criteria to find those that are behaving in a similar manner.
You only need a good stock screener, and trade stocks with good fundamentals. To increase your chances when trading a crossover strategy, it’s good to have fundamentals on your side, this is why i only trade companies what have good perspectives. With a stock screener, you still have to do your homework, but you can set screens to create your watch list based on your crossover conditions and it’s going to save you a lot of time, especially if you’re monitoring hundreds or thousands of stocks.
So, don’t neglect the power of a stock screener, it can help you a lot in your trading. Now, if you found value and learned something new, make sure you subscribe to our channel, turn on the notifications so you don’t miss future uploads and leave us a like to show your support. Until next time. – Reza Abbaszadeh