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How To Trade Moving Averages Golden Cross & Dead Cross

Most Banks and Hedge Funds would trade with a simple moving average as their primary buy/sell signal. Just simple moving average crossovers.  That’s it. Nothing fancy. So how can you trade the moving averages as a buy/sell signal. Let’s get cracking on whats's it all about.

What Is a Moving Average?

Simply put…moving averages are indicators. It helps in finding the trend in the market. Is the market bullish or bearish. Are majority of the people buying or selling at the moment.

For the analytical peeps out there: A moving average (MA) is a line that shows the average of a number of data points on a moving basis like the 20 day or 50 day moving average.

The Formulas For Moving Averages Are:

Simple Moving Average gives equal weighing to all prices in the series

        

Thankfully the system does it for you so you don’t have to manually do the calculation.

For example:  A 20 day moving average calculates the average of 20 days of the data in the chart and plots it. Then move 1 day forward by dropping the first day and adding the next day. The average moves forward and so do the line.

Technical Analyst uses moving average to identify trends in the market to help you spot a buy or sell signals no matter if you are trading stocks, bonds, forex or commodities.

Moving average can be classed as simple, exponential , linear weighted or centred. Each has its own calculation and features.

A well-known technique used in the simple moving average (SMA) is the Golden Cross and the Dead Cross."

50 and 200 SMA is used in this technique.

Golden Cross: A signal is "triggered as an alert" when the shorter moving average i.e. 50 SMA crosses above the longer (200) SMA. But most traders fail to follow the CONDITION.

The condition is to BUY ONLY if the 200 SMA is also rising at the same time.

Example:

 Dead Cross:  Sell Alert happens when the 50 crosses the 200

Again the CONDITION.. the signal is valid only if  the 200 SMA  and the 50 SMA are falling  at the same time.

Example:    

Like any other technique, moving averages has its plus and minus.

Two known disadvantages :

  • They are called lagging indicators as they calculate price that’s 50 days (in this case) behind but some say it’s better to be a little late but sure.
  • They do not work in ranging or choppy markets.

Example below.

  

As you can see in the chart above, there are chances of whipsaws.

Mixed signals hence not reliable on a choppy market.

Works best in a trending market.

Bonus:

It’s always best to use 2-3 moving averages for a fairly reliable signal. Using 1 moving average will give you fewer signals.

Points To Remember:

The long moving average gives you the trend.

The short MA gives you the confirmation of the signal.

Using three moving averages will give you a short term, medium term and long term signal.

TIP: Some traders use Fibonacci number in moving averages.

Take out any chart and look out for it yourself. If you find them then do let me know in the comments section

Happy Trading

Sanchaita

"The most important investment you can make is educating yourself."- Warren Buffett

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