Moving average crossovers are a common way traders use Moving Averages. A crossover occurs when a faster Moving Average (i.e. a shorter period Moving Average) crosses either above a slower Moving Average (i.e. a longer period Moving Average) which is considered a bullish crossover or below which is considered a bearish crossover.
The chart below of the S&P Depository Receipts Exchange Traded Fund (SPY) shows the 50-day Simple Moving Average and the 200-day Simple Moving Average; this Moving Average pair is often looked at by big financial institutions as a long range indicator of market direction:
Note how the long-term 200-day Simple Moving Average is in an uptrend; this is a signal that the market is quite strong. Generally, a buy signal is established when the shorter-term 50-day SMA crosses above the 200-day SMA and contrastly, a sell signal is indicated when the 50-day SMA crosses below the 200-day SMA.
In the chart above of the S&P 500, both buy signals would have been extremely profitable, but the one sell signal would have caused a small loss. Keep in mind, that the 50-day, 200-day Simple Moving Average crossover is a very long-term strategy.
For those traders that want more confirmation when they use Moving Average crossovers, the 3 Simple Moving Average crossover technique could be used. An example of this is shown in the chart below of Wal-Mart (WMT) stock:
The 3 Simple Moving Average method is usually interpreted as follows:
- The first crossover of the quickest SMA (in the example above, the 10-day SMA) across the next quickest SMA (20-day SMA) acts as a warning that prices are reversing trend; however, usually a buy or sell order is not placed yet.
- The second crossover of the quickest SMA (10-day) and the slowest SMA (50-day) finally triggers the buy or sell signal.
There are numerous variants and methodologies for using the 3 Simple Moving Average crossover method, some are provided below:
- A more conservative approach is to wait until the middle SMA (20-day) crosses over the slower SMA (50-day); but this is basically a two SMA crossover technique, not a three SMA technique.
- A money management technique of buying a half size when the quick SMA crosses over the next quickest SMA and then the other half when the quick SMA crosses over the slower SMA.
- Instead of halves, buy or sell one-third of a position when the quick SMA crosses over the next quickest SMA, another third when the quick SMA crosses over the slow SMA, and the last third when the second quickest SMA crosses over the slow SMA.
A Moving Average crossover technique that uses 8+ Moving Averages (exponential) is the Moving Average Exponential Ribbon Indicator (see: Exponential Ribbon).
Moving Average crossovers are important tools in a traders toolbox. In fact crossovers are included in the most popular technical indicators including the Moving Average Convergence Divergence (MACD) indicator (see: MACD).
