Misconceptions About Moving Average Crossover Strategy

What’s moving average?

Moving average is an indicator that calculates the average price of an asset by looking at the previous X number of days or hours. There are a lot of different ways you can weigh and track the moving average. We will get into those later in this post

What is the idea behind moving average cross over trading strategy?

You pick 2 moving averages on the same time frame with different periods. Let’s look at golden cross for example since that’s the most popular MA Cross. It is considered to a good short trade if the 50 day moving average crosses down the 200 day moving average from above. Alternatively, it is considered to be a good long trade when 50 days moving average cross up the 200 days day moving average from below. The idea is that when the markets trend in way or another, the short-term moving average will be crossing up or down the longer-term moving average.

Things to keep in mind so you can grasp the idea better, the price needs to be trending above the both short term and long-term moving average for them to form a bullish cross and vice versa. You can see here how moving averages can track the price effectively. This way, it allows you to be always on the right side of the market. There is no way that the price will be below both moving averages for a considerable time and you won’t be short. Hence, giving you the opportunity to benefit from every single large move.

See how signals are generated at a crossover of moving averages

What is the downside and misconceptions?

Right off the bat, MA crossover strategy will NOT work well in a sideways and choppy market. You will long the top and short the bottom. It will perform so well during a trending market though, it will make up for the losses occurred during the sideways market.

Most people have this anticipation that its too simple of an idea to work effectively. This can’t be further from the truth. Usually the simplest and the most straightforward solutions tend to work and MA crossover is one of them. Now, let’s look at the downside.

It is a trading style that has very low success rate. Most people think an ideal trading strategy should have at least 60% winning trades. While that’s a good rule to have, it is not the only way to be profitable. Most people that running strategies that have 60%-win rate uses 1% TP and 1% SL so their risk to reward ratio is usually around 1:1. However, when in MA cross, people generally use 20% take profit and 1–2% stop loss. Therefore, they can go onto a 5-trade losing streak and catch a nice momentum trade to make it all back plus extra profit. If you want to use 1:1 R: R, MA cross over isn’t the ideal strategy for you. You can see here how the strategy goes through a drawdown stage and the equity curve goes and with coming volatility, it makes up for the previous losses.

This isn’t a scalping strategy! If you are using MA cross over as your trading strategy, you can’t expect to open and close trades within the same day and make 20% profit. It might happen a few times but it is rare. Usually, you get in a trade and you ride the entire way up or down. Of course, that depends on the time frame you are working with. Let’s explore that now.

What’s the best time frame to chart Moving Average Crossover strategy?

Just like everything else in trading, there is no one right answer that will work all the time. Different assets have different ways of forming price action. For this example, we will look at Bitcoin and explore the pros and cons charting across different time frames. First, let’s define the terminology.

Short term means any timeframe below and including the 30min
Mid term means any timeframe between 1hr to 12hr.
Long term means anything above 1 day.

For this example, we will use HFT Research Momentum Indicator which includes a built in Moving Average cross strategy.

Short Term

Choppy market is the worst market condition for momentum trades on 5min

5min MA crossover Bad example during sideways. Why? Because price isn’t moving in any direction in a meaningful way and because we are looking at such a short time frame, moving averages are always close to each other and are more susceptible to smaller moves. Therefore, they keep crossing each other when a small move happens in the market. It does create a lot of noisy trades and the cost of trading might add up quite fast.

This is an example of good market conditions on 5min

Here, you have a better price action and a trending market which is the bread and butter of this strategy. In a short amount of time you can get a few successful and meaningful trades in and avoid getting chopped by sideways action. If you are going to use such strategy it is advised to only use it when the market is trending and be sure to stop it when the market goes into sideways action.

Mid Term

Choppy market on the hourly chart, resulting in drawdown phase

The same principle applies on the 1hour as 5min example, Bitcoin tends to go sideways quite often and MA crossover strategy gets chopped during this time. Most people get discouraged and stop using the strategy only to watch the price explode in volatility. On the hourly chart, you will avoid noises for the most part and you will not be going short and long on a market that’s trending at a bigger scale than what the 5min chart can analyze. However, on the downside, when the market starts trending 1hour will get in a little later than 5min does.

Here you have a volatile market providing the perfect condition for momentum trades

Long Term

When you increase the time frame to daily and above it does magic. Because on the daily and weekly there isn’t much sideways action, you can benefit quite a bit from the legendary bitcoin volatility.

Here is the weekly look for the same Moving Averages

If you like what this indicator can do and would like to get access please check https://hftresearch.com/documentation/momentum-indicator-documentation/

Conclusion

MA crossover is a solid strategy with a mathematical approach behind it. It is limited what you can do with a simple moving average however with moving averages like EMA, TEMA, ZLEMA, HULLMA and many more it is possible to track the price in such a way that’s tailored to the asset that you are trading. Also, you need to accept the nature of having 30% success rate and hitting stop losses often. Do not let that discourage you, use a strict risk management program and stick to the plan. Happy Trading!

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