Overview

The Moving Average (MA) is one of the simplest, yet most versatile and widely used of all technical indicators. Signals to buy or sell are generated when the price crosses the MA or when one MA crosses another, in the case of multiple MAs. As with trendlines, the MA often provides an area of support and resistance. The more times an MA has been touched (i.e., acts as support or resistance) the greater the significance when it is crossed.

Moving averages are considered to be a lagging or trend following indicator.

Pro's and con's of using a trend following/lagging indicator

Trend following indicators work well in trending markets. During strong trends trend following indicators tend to produce less signals, are easy to apply and result in less trading by the investor. These indicators are very effective in strong trending markets and can be very profitable in those situations.

There are two main weaknesses in trend following indicators. In sideways markets a trend following indicator tends to generate a large amount of false signals. This is a result from the second weakness towards trend following indicators. As the name implies, the lagging (trend following) indicator is following/lagging/behind the move. With trend following indicators signals are generated after the move. If the market or security is trading in a sideways pattern trend following indicators will generate their signals after every move and if you act on these signals you will most likely be whipsawed every time.

To protect you from these weaknesses we suggest using a balanced set of complementary indicators, a checklist system along with an understanding of the indicators strengths and weaknesses. This will give you a more robust system as well as protection from false signals generated in non-trending situations.

Indicators which are especially well-suited for being used with moving averages include MACD, Price ROC, Momentum, and Stochastics. A moving average of another moving average is also common.

The different types of moving averages

There are 4 common types of moving averages: simple, linearly weighted, exponential and variable.

Type of MA	Description	Methods Used
Simple (This is the most commonly used MA)	Use of multiple MAs can provide good signals Useful periods Short term 10-30 day Mid term 30-100-day Long term 100-200+day There is no perfect time span	Crossover of short term through long term Convergence/ Divergence Crossover of MA by price
Linearly Weighted	With this MA, data is weighted in favour of most recent observations. Has the ability to turn or reverse more quickly than simple MA.	Warning of trend reversal given by change in direction of the average rather than crossover.
Exponential (EMA)	An exponential (or exponentially weighted) moving average is calculated by applying a percentage of today's closing price to yesterday's moving average value. Exponential moving averages place more weight on recent prices.	Crossover of short term through long term Convergence/ Divergence Crossover of MA by price
Variable	An automatically adjusting exponential moving average based on the volatility of the data.	The more volatile the data, the greater the weight given to the current data and the more smoothing used in the moving average calculation.

Multiple moving averages / double crossover method

It is usually advantageous to employ more than one moving average. Double and triple MAs often provide useful signals. With two MAs the double crossover is used: a buy signal is produced when the shorter average crosses above the longer, and vice versa for the sell signal. The technique of using two averages together lags the market a bit more than a single moving average but produces fewer whipsaws.

Japanese crosses, a variation of the double crossover method

The Japanese cross method is a variation on the double crossover method. The predominant difference is that in Japanese crosses the direction of each moving average is taken into account.

There are only two types of intersections described in Japanese crosses: the dead cross and the golden cross.

The dead cross

The dead cross is when two moving averages intersect moving in opposite directions. This type of intersection indicates that the moving average cross can be disregarded as a false signal.

The golden cross

A golden cross is when two moving averages intersect moving in the same direction. This type of intersection is considered a reliable signal.

Three moving average cross (triple crossover method)

Another variation on moving average cross systems is called the three moving average cross. This method has the advantage of also creating a warning signal prior to the trading signal.

The most common three moving average cross system uses a 4, 9 and 18 day moving average. The warning signal occurs when the 4 day MA crosses the 9 day MA and the 18 day MA. The trading signal occurs when the 9 day MA crosses the 18 day MA.

Supported moving average signals

Simple Moving Averages

Buy when 5 day SMA crosses up through price line
Sell when 5 day SMA crosses down through price line
Buy when 20 day SMA crosses up through price line
Sell when 20 day SMA crosses down through price line
Buy when 50 day SMA crosses up through price line
Sell when 50 day SMA crosses down through price line
Buy when 100 day SMA crosses up through price line
Sell when 100 day SMA crosses down through price line
Buy when 200 day SMA crosses up through price line
Sell when 200 day SMA crosses down through price line

Exponential Moving Average

Buy when 5 day EMA crosses up through price line
Sell when 5 day EMA crosses down through price line
Buy when 20 day EMA crosses up through price line
Sell when 20 day EMA crosses down through price line
Buy when 50 day EMA crosses up through price line
Sell when 50 day EMA crosses down through price line
Buy when 100 day EMA crosses up through price line
Sell when 100 day EMA crosses down through price line
Buy when 200 day EMA crosses up through price line
Sell when 200 day EMA crosses down through price line

Moving Average Crosses

Buy when 4 day EMA crosses up through the 9 day EMA
Sell when 4 day EMA crosses down through the 9 day EMA
Buy when 4 day EMA crosses up through the 18 day EMA
Sell when 4 day EMA crosses down through the 18 day EMA
Buy when 5 day EMA crosses up through the 13 day EMA
Sell when 5 day EMA crosses down through the 13 day EMA
Buy when 5 day EMA crosses up through the 20 day EMA
Sell when 5 day EMA crosses down through the 20 day EMA
Buy when 50 day EMA crosses up through the 200 day EMA
Sell when 50 day EMA crosses down through the 200 day EMA

Triple Moving Average Cross

Buy when 4 day EMA crosses up through the 9 day EMA and then the 18 day EMA
Sell when 4 day EMA crosses down through the 9 day EMA and then the 18 day EMA