Trading moving average crossovers is an effective trend-following technique used by many successful traders. To master this technique for your trading, however, there are a number of things you need to know.
Moving average crossovers in trading
A moving average calculates the average price of the last periods. The moving average repeats the process for each period in your chart, always using the last periods from the respective period’s position. For each period, the result is drawn into your chart, thereby creating a line. The position of this line in relation to the current market price can generate trading signals.
By defining how many periods you use to calculate your moving average you can vary the nature of your moving average crossovers. A moving average based on only a few periods is agile and stay close to the current market price. The more periods you use to calculate the moving average, the slower the moving average will be to react to price movements and the further the moving average will be from the current market price.
Using the crossover to generate signals
Most of the time, the moving average and the market will move in the same direction. In times of changing market direction, however, the moving average will be slower to react. Depending on how many periods you use to calculate the moving average, the moving average’s delayed reaction will cause the market to cross the moving average sooner or later.
This crossover is a trading signal.
When the market crosses the moving average upwards, it creates a buying signal. When the market crosses the moving average upwards it creates a long signal. When the market crosses the moving average downwards it creates a short signal.
When a trend changes direction, these signals create very good investment opportunities and generate a high percentage of winning trades if you use High / Low options. At first glance, this strategy seems easy and successful. There are, however, some problems.
In times of sideways market movements the market can cross the line of the moving average a number of times and create invalid signals. Also, once the market has crossed the moving average, it does not necessarily remain on one side, even if the trend remains intact. Retracements and market fluctuations can cause the market to cross the moving average again and create short lived false signal.
Eliminating false signals
If you trade all of these signals, your winning percentage will suffer greatly. Short swings across the moving average will already have moved back across into the other direction when your binary option expires and you will lose your trade. With a strategy like this, there is no guarantee you will win the 70 to 80 percent of your trades necessary to make a profit with binary options.
There are, however, a number of ways to improve your strategy:
- Wait for a number of periods to confirm the crossover: When the market crosses the moving average, you can wait for x numbers of period to see if the market swings back quickly. If it does not but does continue to move away from the moving average you can invest in a binary option more safely.
- Wait for the crossover to extend: To eliminate false signals you can make it a rule that the market has to cross the moving average for minimum extension before you invest. You can calculate this minimum extension by using a percentage of the asset’s price, an average of the last periods trading ranges, or another relevant value generated by a technical indicator.
- Search for increased volume: You can only invest in crossovers that are accompanied by an increase in volume.
- Using highs and lows instead of closing prices: In an uptrend, you can make it a rule that the low of a period has to cross the moving average, not just the closing price. Conversely, in a downtrend, the high has to close the moving average before you invest in a change in trend direction.