The moving average is a popular indicator among traders due to its simplicity and accuracy when it comes to identifying high-probability potential trade setups. There are two types of moving averages: the simple moving average (SMA) and the exponential moving average (EMA). Although they are calculated differently, they are used in the same manner.
There are also two types of moving average (MA) crossovers. The first one occurs when price crosses above or below a moving average, while the second one can be seen when a faster MA crosses above or below a slower MA. Here is a look at both types of crossovers.
When price crosses above or below a moving average
This type of moving average crossover occurs when an asset’s price crosses above or below a particular moving average, indicating a shift in the trend direction. An instrument is typically considered to be in an uptrend when the price crosses above a specific moving average; the opposite is true for scenarios where the price crosses below the MA.
Chart 1: MA price crossover trade entries
The above chart shows MA crossovers generated by the USD/JPY currency pair on the daily time frame since the beginning of 2019. You can see that the 20-day MA provided three excellent trade opportunities up to mid-September, when this article was written.
This is a simple trading strategy that would not have generated many trade signals but would have kept you in trades long enough to capture profits worth hundreds of pips.
Some traders prefer to use MAs with a wider length, such as the 50, 100, and 200-day MAs, but these would generate even fewer trade signals and may only be suitable for very long-term traders (position traders) who hold their trades for years.
Trading based on crossovers between two moving averages
The second type of MA crossover is the one where a faster moving average crosses above or below a slower moving average. This type of crossover is used by traders who prefer to have a solid confirmation that the price trend has indeed shifted. This is because the price usually crosses above or below the faster MA before this type of crossover occurs, which means that you could choose to use the faster MA without including the slower MA.
Chart 2: Trade entries generated from crossovers between two MAs
This is the same chart that was used for the first type of crossover. As you can see, the crossovers between the faster and slower MAs happen much later than the price crossover of the faster MA explained in the first section.
However, this type of crossover makes sense when your initial MA was a slower moving average covering periods larger than 40, in which case adding a faster MA to the chart would get you into trades much earlier than if you were to rely on the slower MA.
Trading MA crossovers on intra-day charts
The moving average is a versatile indicator that works on the higher time frame charts, such as the daily and weekly charts. It works just as well on the intra-day charts, as shown below.
Chart 3: MA crossovers on the USD/JPY 1-hour chart
The above chart shows trade signals generated by both the 20-period and 40-period moving averages, resulting in several high-probability trade setups. You can clearly see that price crossed above the slower and faster MAs almost at the same time and that the two MAs crossed over each other just a few hours later. This means that regardless of how you chose to use the two MAs, you would have still generated very solid trade signals from both types of crossovers.
The bottom line
The length of the moving average you choose to use will determine the number of trade signals generated as well as their quality. The faster MAs usually generate more trade signals but are also prone to generating false signals that could lead to losses. The slower-moving averages tend to generate fewer trade signals but will generally get you into a trade much later than the faster MAs. Therefore, you should choose the MAs that you want to use based on your personality as a trader as each MA has its advantages and disadvantages.