Technical analysis is one of the most widely used tools in trading. Moving average crossovers is a relatively straight-forward analytical tool that I like to use to choose stocks to buy.
Moving average crossovers:
- uses two different moving averages in its analysis;
- identifies when a faster-moving (i.e., shorter-term) average crosses a slower-moving (i.e., long-term average; and
- smooths out noise in price data to show you when the market might be speeding up or slowing down.
I use moving average crossovers as my preferred stock market analysis tool since I’ve found the indicator to work on a consistent basis. I’m using the indicator and options to express my opinion on an underlying stock. For example, if I see a bullish moving average crossover on the hourly, I would look to purchase call options. On the other hand, if I see a bearish crossover, I would look to get into put options.
That said, let’s take a look at how to use trading moving average crossovers to potentially multiply your capital.
How to use moving average crossovers
The moving average crossover is an “easy-to-use” indicator and helps to remove some of the emotions from trading. That means that if you learn how to use moving average crossovers properly, you could see some benefits.
For example, let’s assume you are new to trading and buy a stock because you are bullish on the name. Well, what happens if it starts to move against you? You could use moving average crossovers as a signal to stop out of your position. When you’re using a moving average crossover strategy, there are clear signals and you wouldn’t just hold onto the stock in hopes of it rebounding. In other words, when you use moving average crossovers, you’re not just placing a bet and hoping that the market will turn in one direction or another; rather, you’re doing a simple yet effective analysis to give you actual data about what direction the market is likely to be moving in.
Generally, I use the indicator to signal entries. I use the 13-period simple moving average (SMA) and the 30-period SMA on the hourly chart for my signals. If the 13-period SMA crosses above the 30-period SMA, I would look for a spot to enter long. Conversely, if the 13-period SMA crosses below the 30-period SMA, I would look for a spot to get short, or purchase put options. Learning how to use moving average crossovers could uncover some trading opportunities.
Here’s a look at an example of a moving average crossover on the hourly chart of the SPDR S&P 500 ETF (SPY).
Here’s a look at two moving average crossovers on the hourly chart. First, you should notice how the 13-period SMA crossed above the 30-period SMA. This is an entry signal long. Assuming you got long on the crossover, you could define your own target price. However, if you cannot figure that out, you could exit when the 13-period SMA crosses below the 30-SMA with some room between each other.
Moving on, let’s take a look at a trade in which I used moving average crossovers to get into options on the underlying stock.
How to use moving average crossovers with options
Moving average crossover isn’t just a technique for buying stock — you can also use this tool when you’re assessing options. Take a look at the VanEck Vectors Gold Miners (GDX) on the hourly chart as an example:
The trading community was watching this for a few weeks at the time, and I missed the trade when the 13-period SMA crossed above the 30-period SMA. Even though I missed the trade, I figured there would be a potential short trade once the 13 SMA crossed below the 30 SMA. Luckily, this time I had GDX on my radar.
If you notice the chart above, the 13-period SMA looked like it had potential to cross below the 30 SMA. Now, this worked on the way up, so I figured this would work on the way down. Additionally, around a 10% in GDX over this period was a big move. I thought GDX was losing steam, so I purchased 200 GDX put options with a strike price of $23.50 at 28 cents a piece. This was a capital outlay of $5,600.
Here’s what happened after:
Well, off of this small move, I was able to make 105% of my initial capital outlay, or $5,800. This all happened in just a few days. That’s the beauty of options. You’re able to leverage your capital and multiply your money on small moves. Moving average crossovers is the tool that helped me to identify this lucrative options trade and make a lot of cash in just a few days.
If you’re first starting out to trade, I think learning how to use moving average crossovers could be beneficial. Using moving average crossovers could help with signals and exits, as well as handling emotions. Now, you don’t need to use options along with moving average crossovers, you could purchase or short stocks if you see the signal. However, you should understand how short selling works before you go out and short sell a stock when you see a crossover.
Jeff Bishop is lead trader at WeeklyMoneyMultiplier.com and widely recognized as the Mensa Trader. He runs short-term trading strategies, using stocks, options and leveraged ETFs.