A moving average is one of the most popular technical indicators. Traders frequently use them to discern trends, identify reversals, and locate support and resistance levels.
Let’s look at these powerful technical tools and one unique event: the moving average crossover.
What Is a Moving Average Crossover?
Moving average (MA) is a “calculation used to analyze data points by creating a series of averages of different subsets of a complete data set,” according to Investopedia.
As it applies to the capital markets, an MA is an indicator that represents a smoothed representation of price action. MAs come in many types. These are the most commonly used by active traders:
- Simple moving average (SMA): The simple moving average is the most basic type of MA. It is calculated by taking an average of a specified data set.
- Exponential moving average (EMA): An exponential moving average is more involved. To be a more current representation of price action, the EMA adds more weight to recent data sets.
- Smoothed moving average (SSMA): The smoothed moving average is a complex calculation that aims to build a representation of price action. SSMAs use a longer periodicity and give weight to more recent values to produce a comprehensive picture of price action.
A moving average crossover occurs when an EMA, SMA, or SSMA intersects with another EMA, SMA, or SSMA. This event is local to price charts with at least two MA overlays on price action.
The MA crossover conveys the following information to the trader:
- A possible weakening or reversal of the prevailing trend.
- A potential increase of bullish or bearish price action.
- A signal to buy or sell the market.
Crossovers typically occur when a faster MA (smaller periodicity) approaches and intersects with a slower MA (longer periodicity). Let’s dig into the two most prominent types of crossovers: the golden cross and the death cross.
What Is the Golden Cross?
The golden cross is a moving average crossover in which a short-term MA breaks above a long-term MA. It suggests that bullish price action is pending and that buying the market is a viable trading strategy.
Traders may use the golden cross to evaluate the market state of individual shares, indices, futures, or forex products. One common periodicity combination for the golden cross is the 50-day and 200-day simple moving averages. When the 50-day crosses over the 200-day, upward pricing momentum is thought to be developing.
To illustrate the golden cross’s functionality, assume that Sam the stock trader is evaluating Twitter (TWTR) shares using 50-day and 200-day simple moving averages. When the 50-day eclipses the 200-day SMA, the golden cross occurs. In response, Sam buys TWTR in the hopes of capitalizing on a fledgling bullish trend.
What Is the Death Cross?
The death cross is the polar opposite of the golden cross. It occurs when the short-term MA crosses beneath a longer-term MA from above. In this instance, the crossover suggests a bearish trend is in the offing.
Traders often perceive a death cross as a signal to sell a market. This time, assume that Sam the stock trader is studying the S&P 500 equities index with 50- and 200-day SMAs. The 50-day SMA falls and crosses the 200-day SMA with a downward trajectory. As a result, Sam decides to sell deferred month E-mini S&P 500 futures and buy an inverse ETF facing the S&P 500.
Want to Learn More About Market Technicals?
The golden and death crosses are two of the most popular indicators in the technical analysis universe. However, they aren’t the only ones!
To learn more about the power of market technicals, check out the StoneX guide, 10 Rules For Technical Futures Trading. In it, you will find actionable tips for reading charts, identifying market entry and exit points, and recognizing patterns. If you’re an aspiring market technician, sign up for your free copy here.
Image and article originally from www.danielstrading.com. Read the original article here.