I was recently asked a basic question that got me thinking…
Are moving averages even valuable for trading?
And almost immediately I responded – no way!
But I decided to think about it more carefully before responding.
And a series of thoughts started racing through my head, stuff like:
“Moving averages are useless since they are lagging”
“Moving averages are for newbies”
“Moving averages are confusing to understand”
But here’s the thing… I couldn’t answer no.
You know why?
Because I’ve called the market direction nine out of the last ten times…
And my secret weapon was just some basic indicators you can find on any trading platform.
What are they? You may have guessed it… The Moving Average Crossover strategy!
And wow does it work! It just predicted the markets dropping nearly 1% yesterday, and you’ll be surprised to hear what it’s showing next. But before we get into those details, it’s important that you understand the mechanics of the moving average crossover strategy.
Moving Average Crossovers
After many years in the trenches, I can tell you that moving averages are one of the most versatile trading indicators I have ever used.
As an added bonus: They can be used in many different ways! Just like those favorite jeans you have.
Up, down, or sideways markers, EMA’s get the job done since they are used for finding support and resistance levels, stops prices, and targets.
I call them the Swiss Army knife of trading tools and there are a number of different ways to use it.
Many ways to trade this strategy include :
- Trade with the trend
- Trade against the trend
- Using moving averages to find stop prices
- Using moving averages to find target prices
One of my personal favorites is using moving averages to find reversals in the SPY’s.
The basics of a trend
Moving averages help to identify many characteristics about a stocks trading patterns.
One of the most popular ways to use them is to identify if a stock is currently in an uptrend or downtrend.
In the SPYs above, the EMA is pointing higher and the price is above it. Therefore, you can conclude that the short-term trend is up.
Alternatively, the EMA is pointing lower and the price is below it. Therefore, you can conclude that the short-term trend is down.
Finding the change of direction is one of the many strengths of using moving averages to determine which trend you are in.
As the image above shows, the SPY’s price-action has changed dramatically once the stock traded under the EMA.
From this image, you can see that this signaled a change in trend in the SPY’s.
The SPY’s began the holiday week in a strong uptrend and signals the start of a downtrend over the course of the last two days.
How to set up moving averages to find reversals
Using moving averages to find major trends of the stock is straight forward.
Moving averages can also be used for finding reversals with a few minor adjustments.
Price is attracted to the moving averages
In this chart, it’s easy to see that the stock price attracted to the moving average and moves right towards it.
Later in the week, the SPY’s price was brought right back to the EMA level indicating that the moving average is acting like a magnet to the stock.
The Moving Average Crossover
Now that it’s easy to see exactly how the moving average impacts the stock price let’s take a look at a different way to signal potential short-term trend changes.
The tool that I routinely use is called the Moving Average Crossover.
What is a Crossover?
It occurs when two moving averages are conflicting with one another. This is typically seen with the slower average showing a bullish trend and the faster average showing a bearish trend.
How does this help us?
This is a strong indicator of change of direction and it has become my go-to for finding reversals in the SPY’s with surprising accuracy.
Last week on the SPY’s, the shorter moving average crossed above the longer moving average with strong price action.
This signaled a huge buying opportunity, and the SPY’s had a strong run higher over the next few days.
Putting It All Together
SPY’s had a major crossover with the faster ema crossing over the slower ema right at the same time the technical pattern “Double Top” occurred overnight.
This signaled major selling was about to come for the SPY’s, and shortly afterward the momentum picked up to the downside.
It really is incredible exactly how versatile moving averages can be when used properly.
When I finally understood how moving averages worked they instantly became a go-to tool in my trading toolbox.
This tool has picked the top in the markets. At least for right now.
It’s still too early to tell if the moving average will cross and signal higher prices or just act as a magnet as the SPYs just continue to trade lower.
Only time will tell what will happen.