So far, you have learned how to determine the trend by plotting some moving averages on your charts.
You should also know that moving averages can help you determine when a trend is about to end and reverse.
As trend traders, you want to recognize and ride the trend for as long as possible.
You have to know when to get in AND when to get out.
A trend can be defined simply as the general direction of the price over the short, immediate, or long term.
Some trends are short-lived, while others last for days, weeks, or even months.
But you don’t necessarily know how long a specific trend will last.
A technical tool known as a moving average crossover can help you identify when to get in and out.
A moving average crossover occurs when two different moving average lines cross over one another
Because moving averages are a lagging indicator, the crossover technique may not capture exact tops and bottoms. But it can help you identify the bulk of a trend.
A moving average crossover system helps to answer these three questions:
- Which direction might the price be trending (if at all)?
- Where might be a potential entry point for a trend trade?
- When might a trend be ending or reversing?
If the moving averages cross over one another, it could signal that the trend is about to change soon, thereby giving you the chance to get a better entry. By having a better entry, you have the chance to bag mo’ pips!
If Allen Iverson made a living by having a killer crossover move, why can’t you?
Let’s take another look at that daily chart of USD/JPY to help explain moving average crossover trading.
From around April to July, the pair was in a nice uptrend. It topped out at around 124.00, before slowly heading down. In the middle of July, we see that the 10 SMA crossed below the 20 SMA.
And what happened next?
A nice downtrend!If you had shorted at the crossover of the moving averages you would have made yourself almost a thousand pips!
Of course, not every trade will be a thousand-pip winner, a hundred-pip winner, or even a 10-pip winner.
It could be a loser, which means you have to consider things like where to place your stop loss or when to take profits. You just can’t jump in without a plan!
What some traders do is that they close out their position once a new crossover has been made or once the price has moved against the position a predetermined amount of pips.This is what Huck does in her HLHB system. She either exits when a new crossover has been made but also has a 150-pip stop loss just in case.
The reason for this is you just don’t know when the next crossover will be. You may end up hurting yourself if you wait too long!
One thing to take note of with a crossover system is that while they work beautifully in a volatile and/or trending environment, they don’t work so well when price is ranging.
You will get hit with tons of crossover signals and you could find yourself getting stopped out multiple times before you catch a trend again.
In summary, moving average crossovers are helpful in identifying when a trend might be emerging or when a trend might be ending.
The crossover system offers specific triggers for potential entry and exit points.
These triggers should be confirmed with a chart pattern or support and resistance breakouts (which you’ll learn about later in the School).