Perhaps one of the simplest trading strategies of all is that of the moving average exponential moving average in forex trading. Simple and exponential crossover strategies have a wide variety of uses.
They are straightforward yet can be surprisingly effective. Crossover is best suited to trend following and momentum strategies. A number of sophisticated trading systems use crossover as their underlying approach. The principle behind the crossover system is that it tells us a trend is changing. To understand this, take a look at the four charts in Figure 1.
2, the price line starts to fall. 3, all three lines are falling. The price, moving average 1 and moving average 2 are now all on the same path again after the price changed direction from rising to falling. 4, the price starts to rise again and the same process happens again but in reverse. The blue line is the first to react to the price turning followed by the red line.
The length of time that the moving average uses in its calculation is the period. Moving average 1, the blue line, is a fast moving average because it uses fewer data points, or a shorter time period in its calculation. Moving average 2, the red is a slow moving average because it takes a larger sample of points and therefore has a slower reaction time to changes in price. The longer the period of the average, the more stable the line is but the slower it is to react to changes. Crossover Events A crossover occurs when two different moving average lines cross over one another. This takes place when a fast moving average crosses down through a slow moving average.
This implies that the trend is falling or becoming bearish. 4, the trend changes again and this produces a bullish crossover. The blue, or fast moving average, is the first to react. It crosses up through the slow line.
After the crossing, all three lines then follow the same path as the trend continues upwards. Some might say why not just look at the price, because that tells us instantaneously what’s happening. The reason for using the averages rather than the price is that in real markets, trends do not move in straight lines but rather follow meandering paths with many false stops and starts. The purpose of the average lines is to smooth out the random movements and discover the underlying price trends. The first and most basic problem that a crossover trader faces is which moving average pair to use. In hindsight we can always back test a market to find some unique moving average pair that will create a profitable strategy. Yet this is of little use because as we all know the past is not necessarily a reliable predictor of the future.
The Death Cross and the Golden Cross Perhaps the most common pairing is the 50-day verses the 200-day moving average. When the 50-day cross up through the 200-day moving average this is said to be a golden cross. It signifies to many the possibility of a new bull market. On the flip side, when the 50-day moving average crosses down through the 200-day moving average this is said to be a death cross.