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There are any number of moving average pairs that offer the consistent trader a reliable means of identifying the current trend as either bullish or bearish. As I explained here, the traditional measures – the 50- and 200-day moving averages – are by no means the sole qualified duo.
But moving averages can also be used to identify a potential weakening of the trend, when the short-term average crosses over the long. It has to be stressed, however, that crossovers are not definitive indicators of a change in trend. They simply reveal a slowing of momentum, and taken together with other indicators can furnish the astute technical analyst with potentially valuable trading data.
Have a look here:
In this chart of Apple (NASDAQ:AAPL), the 50-day moving average (brown) crossed below the 200 DMA (blue) in late August, and as the chart shows, that would have been a reasonable exit point for an existing long position, or entry point for a short.
In the following chart, we see the opposite:
Above is the Dow Jones Industrial Average for the better part of a year. Here, too, we see a crossover of the 200 DMA by the 50 DMA – in both directions. The first, unfortunately, would have provided a false sell signal, as the price bottomed and the uptrend continued a mere six weeks later.
The second cross higher would have been an outstanding long entry point, however, as the Dow moved aggressively higher in the following months.
Adding Moving Averages to Enhance Signal Reliability
Many traders employ multiple moving averages in order to better apprehend a change in trend.
The two charts below demonstrate how this works.
The above chart is of the iShares China Large-Cap ETF (NYSEArca: FXI). It demonstrates how longer-term MAs coupled with shorter tend to roll over and “unfurl” completely at critical turning points. This is the case in late August in the chart above, when the Chinese market gave a technical buy signal (in red).
Traders who follow the market in this manner will certainly not catch the turns at the precise top or bottom, but they will eliminate a great many false signals and ensure that the longer-term trend is identified with greater certainty.
This chart of the Market Vectors Gold Miners ETF (NYSEArca: GDX) is a wonderful example of four moving averages unfurling lower (red circle), providing a reliable short sale entry point – even though it occurred a full half year after the security topped out!
Examining Several Moving Average Trading Horizons
There is another way of eliminating the noise and adding an important layer of security to your moving average analysis, and that’s by examining both daily and weekly moving average crossovers.
Have a look, for instance, at the following two charts of the Market Vectors Coal ETF (NYSEArca: KOL) – one daily, the second, weekly.
As you can see, the initial daily sell crossover occurred in the summer of 2011 (top red circle). But only a year later was the call confirmed by the weekly cross lower (bottom red circle).
By that time, traders were a long way from the top, but could be more certain that a secular bear market was in place. Additional false signals on the daily chart were also never confirmed by the weekly chart, so could be safely ignored, leaving the shorts in place and the profits to run.
Note: This technique can also be employed by short-term traders by comparing one- or five-minute crossovers with half hour or hourly rollovers.
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