Moving Average Basics: Crosses and Bounces - Timothy Sykes

# Moving Average Basics: Crosses and Bounces

Technical indicators can be useful, but I’d rather you focus on patterns like THESE.

Anyway, here’s a guest blog post from a new trading challenge student who loooooves technical indicators:

Moving averages are a common and useful technical indicator. The two most common varieties are the simple moving average (SMA) and the exponential moving average (EMA). A moving average is an average of x past data points. You will see things like SMA(20) or some other number. That means it averages 20 past pieces of information. This number is calculated at each interval and plotted and then a line drawn to go through all the points. A simple average weights all the data points equally in the average. The exponential moving average placing greater weight on the more recent data points.

Download the key points of this post as PDF.

For our purposes here the simple moving average is enough, but everything applies to both the SMA and the EMA for the most part. Preference dictates who prefers what. The SMA is not usually one line. Most traders will use two or three. Normally, it is some combination of the 20, 50, 100, and 200. It is the 100 that is the rarer one. A lot of times you will see people refer to the numbers as daily moving averages, and you might see people falling into the trap of always calling it the 100-day moving average or something else.

If the moving average is calculated with the daily information then it is accurate, but if it is just the last 100 data points then it could be anything from 100 5-minute bars to 100 1-hour bars. Normally the scale the chart lets you know the information, but advanced charting software can plot the 100-day moving average on a chart with only 5-minute candles. When looking for your signals be aware of the data that you are analyzing so as not to draw false conclusions or have false confidence regarding conclusions.

Crosses – The Reversal

Crosses are major trading signals that refer to a faster moving average crossing a slower one. This can be in the upward direction or the downward direction. Crosses are usually only useful when the candlesticks represent one day. Crosses like the 50-day moving average crossing the 100-day moving average can be a significant change in the recent trend.

Crosses are significant enough that there are websites, newsletters, and guys on twitter that mention them when they happen. Validity of crosses as a law of the universe notwithstanding a lot of traders and investors pay attention to the crosses. A lot of significant movement can happen a short time after a cross. The trend might be long-lived but could have corrections and other similar things. A cross can indicate the change of a multi-month trend. A trader can be in and out quickly with a nice profit, and move on. Long-term investors take the risk of corrections or false positives in an attempt to manage greater gains over time. Traders can use the sentiment attached to crosses to grab a few percentage points of gains.

Bounces – The Continuation

The opposite of crosses are bounces. This is when the faster moving average (SMA 50 is faster than SMA 100), bounces off the slower moving average. This means that a short-term trend contrary to the long-term is not going to turn into a long-term trend. The share price will continue on the long-term term trend after going down and bouncing off the slower average. The 100-day and 200-day moving averages are seen as levels of support.

This is done in two ways. First, the moving average can bounce. The 50 can bounce off the 100 meaning that the larger trend is intact despite the recent foray in the other direction. You can also use the moving average as a support for the actual candle. The candles interact with the moving averages just like other moving averages. The slower average can be seen as forming a level of support for the actual price not just the other moving average, and the use of the candle versus another moving average is quicker but riskier. As you can see moving averages can be quite flexible, it is up to the trader to use them.

Conclusion

Even if you do not believe in the power of charting or technical indicators as being as certain as gravity the market pays attention to these commonly held beliefs and signals. Traders use sentiment to their benefit, and moving averages form some of the most commonly used indicators out there. It is right up there with the RSI and MACD. The rest of the indicators like stochastics are used far more rarely. The prevalence of these indicators is probably due to ease of use and clarity of their signals. The question of their usefulness compared to other indicators is uncertain, but they would not have such prominence among traders if they were not useful. Bounce plays tend to resolve themselves faster than crosses. Crosses might take some time to actually yield the desired benefits.

Posted in Basics

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1. keith

A variation is to take the percentage difference between the moving averages, then you get the turn and can see before they may cross over. It can be taken one step further by doing a least squares regression (or effectively an equation) of the %diff line and project it forward – but that adds risk