Moving Average Crossovers
A popular use for is to develop simple trading systems based on moving average crossovers. A trading system using two moving averages would give a buy signal when the shorter (faster) moving average crosses above the longer (slower) moving average. A sell signal would be given when the shorter moving average crosses below the longer moving average.
The speed of the systems and the number of signals generated will depend on the length of the moving averages. Shorter moving average systems will be faster, generate more signals, and be nimble for early entry. However, they will generate more false signals than systems with longer moving averages.
Some Examples
In Apple, Inc.'s (AAPL) daily chart below, a 30/100 (EMA) crossover generated buy and sell signals.
As with all trend-following systems, the signals work well when the stock develops a strong trend but are ineffective when the stock is in a trading range. The one generated in Nov 2023 was a good entry point for a long position. However, the exit signal based on the moving average crossover generated on March 2024 would have given back some profits.
In the example below, a 20/60 EMA crossover system generated several buy and sell signals.
The plot below the price is the 20/60 EMA differential, shown as a percent and displayed using the PPO set at (20,60,1). The dashed blue lines above and below zero (the centerline) represent the buy and sell trigger points. Using zero as the crossover point for the buy and sell signals generated too many false signals. To reduce the number of signals, you can set the buy signal just above the zero line, say at +2%, and the sell signal just below the zero line, at -2%. A buy signal is in force when the 20-day EMA is more than 2% above the 60-day EMA. A sell signal is in force when the 20-day EMA is more than 2% below the 60-day EMA.
If a stock fails to hold a trend, you'd have to place tight stop-losses to lock in profits. A trailing stop or use of the parabolic SAR might have helped lock in profits.
The Bottom Line
Moving average crossover systems can be effective but should be used with other aspects of technical analysis (patterns, candlesticks, momentum, volume, and so on). While it's easy to find a system that worked well in the past, there is no guarantee it will work in the future.