3 moving average crossover system

The Triple Moving Average System By Dr. Winton Felt The triple moving average crossover system is used to generate buy and sell signals. Its buy signals come early in the development of a trend, and its sell signals are generated early when a trend ends. The third moving average can be used in combination with the other two moving averages to confirm or deny the signals that they generate. It thereby reduces the chance that the investor will be acting on false signals. The shorter the moving average, the more closely it follows the price trend. When a stock begins an uptrend, short-term moving averages will begin rising far earlier than longer-term moving averages. For example, if a stock declines by equal amounts each day for 50 days, and then begins to rise by the same amount each day for 50 days, the 5-day moving average will start to rise on the third day after the change in direction, the 10-day average will begin to rise on the sixth day after the change, and the 20-day average will begin to rise on the eleventh day. The longer a trend has persisted, the more likely it is to continue persisting, up to a point. Waiting too long to enter a trend can result in missing most of the gain. Entering the trend too early can mean entering on a false start and having to sell at a loss. Traders have addressed this problem by waiting for three moving averages to verify a trend by aligning in a certain way. To illustrate, wersquoll use the 5-day, 10-day, and 20-day moving averages. When an uptrend begins, the 5-day moving average will start rising first. Traders view this as interesting but of no major significance. As the upside momentum increases, longer moving averages gradually begin to follow suit. A buying alert takes place when the 5-day crosses above both the 10 and the 20. That is, the average price of the stock over the last five days is greater than its average over both the last ten days and the last twenty days. This shows a short-term shift in trend. A buy signal is confirmed when the 10-day then crosses above the 20-day. The 10-day average price of a stock is more meaningful than the 5-day average price. If the average price over the last ten days is greater than the average price over the last twenty days, the shift in momentum is considered to be much more significant. Conversely, when an uptrend changes to a downtrend, the first thing that happens is that the 5-day declines below the 10-day and 20-day averages. This constitutes an alert that a sell signal may be forthcoming. The confirmed sell signal occurs when the 10-day crosses below the 20-day resulting in an alignment in which the 5-day average is below the 10-day average and the 10-day average is below the 20-day average. More aggressive traders often use the alert crossover as the actual sell signal because it locks in more of the profit. However, the risk of doing this is that the stock may only be quotcatching its breathquot before continuing its advance. The confirmed sell signal could then take place at a much higher price. Therefore most traders consider the sell signal to be generated by the 10-day crossing below the 20-day. I recommend using the 5-day moving average as a filter for each crossover event. That is, alignment can be used as a tool to reduce whipsaws. For a buy signal, the appropriate alignment is for the 5-day average to be above the 10-day, and for the 10-day to be above the 20-day. For a sell signal, the 5-day would be below the 10-day and the 10-day below the 20-day. If the 10-day has just given a buy signal by crossing above the 20-day average, a trader might abstain from making the purchase if the 5-day is now declining or below the 10-day average. The purchase would be made only if the 5-day resumes its ascent or is above the 10-day average while the 10-day average is still above the 20-day average. If the 10-day average gives a sell signal by crossing below the 20-day average, the trader might abstain from selling if the 5-day average has turned and is now rising, or if it is now above the 10-day average rather than below it. The sale would be made only if the 5-day resumes its decline or falls below the 10-day average while the 10-day average is still below the 20-day average. Our stockdisciplines traders have learned through experience that using the 5-day average in this way can dramatically reduce whipsaws (untimely and unnecessary buying and selling). The reason these alignments are important is because the shorter moving average is extremely sensitive to the development of a counter-trend in the stockrsquos price. If a trend counter to the trend indicated by the crossover of your major moving averages is developing, it makes sense to wait for that counter-trend to dissipate before taking action. Investors and traders might be wise to incorporate another indicator into their decision-making. To increase the reliability of the signals given by the system outlined above, it might be wise to use the 50-day moving average as a context and reference. The best and most profitable time to buy a stock is early in a new trend. Later buy signals carry greater risk that the stock will soon decline (because stocks donrsquot go up forever). Therefore, if the 50-day average has been in a significant decline and is now leveling off or just beginning to rise, a buy signal using the triple crossover method outlined above has a greater chance of success than if the 50-day average has been rising for a long time, or is beginning to level off or decline after a prolonged advance. In other words, the intermediate-term 50-day average can be used to confirm and quotsupportquot the signals given by the shorter-term moving averages. Generally, itrsquos better to avoid buying a stock if its 50-day moving average is in decline. A short-term trader might make an exception to this general policy in order to profit from a snap-back toward the declining 50-day average from an extreme oversold condition. When a stock is not trending (when itrsquos going sideways) the moving averages will intermingle and repeatedly crisscross each other. Here, the actual crossovers become worthless as buy or sell signals. However, the condition represents either consolidation or distribution. Thus, traders may look at these times as foundations for good entry or exit points, depending upon their conclusions about what the stock is most likely to do next or on specific breakout behavior. Various chart configurations (rising triangles, flags, etc.) can give clues about the stockrsquos probable behavior once it begins to move again. The reader can also get hints about a stockrsquos inclination by observing whether the volume increases or decreases when the stockrsquos price rises or falls. For example, if volume increases on down days and declines on up days, the stock is announcing its determination to go down, and so on. The volume gives clues about the direction of stock movement to which money is being committed. Finally, the trader can simply wait for the stock to quotshow its handquot by breaking through support on the downside or through overhead resistance on the upside. In either event, the move is not very trustworthy without a significant increase in volume. Get more on this, and see a list of tutorials on disciplines for investors and traders. Copyright copy 2008 - 2017 by StockDisciplines a. k.a. Stock Disciplines, LLC Dr. Winton Felt maintains a variety of free tutorials, stock alerts, and scanner results at stockdisciplines has a market review page at stockdisciplinesmarket-review has information and illustrations pertaining to pre-surge quotsetupsquot at stockdisciplinesstock-alerts and information and videos about volatility-adjusted stop losses at stockdisciplinesstop-losses Notice to Webmasters If you wish to publish this article on your blog or website, you may do so if and only if you abide by our Publisher39s Terms of Use and Agreements . By publishing this article, you thereby agree to abide by and to be bound by our Publisher39s Terms of Use and Agreements . 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See them by clicking on their links near bottom of menu on left side of every page. Moving Average Crossover Strategy On this page Id like to take you through a comparison of a couple of moving average crossover systems. One uses two simple moving averages (smas) and the other uses three smas. Ever thought about using a dual moving average system to trade If youre considering using dual moving average crossovers to both enter and exit trades, you might consider testing a triple MA system too. Compare them side by side on different stocks or other trading instruments as well as different time periods or time frames. Test different moving average periods, but be careful not to rely on optimized or curve-fitting results. But since some of my visitors dont know what this is, lets go over some basics first. WHATS A MOVING AVERAGE CROSSOVER The image on the right is an example of a dual moving average crossover . that would initiate a buy signal (bullish crossover). A faster moving average (8 sma - blue) crosses above a slower average (13 sma - yellow). Notice that the signal is not confirmed until the close of the bar. This means the actual entry (in live trading) would be somewhere within the next bar. Most likely near the open of that bar. If you havent done any backtesting yet, this kind of simple system will probably be one of the first that youll test, since it requires very little programming skills. Anyway, if you go down this path, youll find that the opening price of the next bar after the cross, is where backtesting software (depending on the setting) will place the simulated trades. Which is reasonable, because if you were actually trading using automated trading software. this is a close approximation of where your trade would take place. With a typical stop reverse system, this long entry would not be exited until the blue, faster MA crossed below the yellow, slower MA. This MA bearish crossover not only exits the trade, but initiates a short trade in the opposite direction as well. So, with dual moving average crossover systems, the trader is always in a trade, long or short. Lets take a look at an intraday example over the course of one day. DUAL MOVING AVERAGE CROSSOVER Well use a 5 minute chart of SPY with two simple moving averages for the first example: Fast (8 sma - green) and Slow (13 sma - yellow). I chose this particular day, because I wanted to illustrate what is very typical for practically any moving average crossover strategy. The first long trade after 11:00am goes very well and actually catches a good pullback entry. The exit at around 12:45pm is profitable. But, want Id like you to observe is the choppy price action between 12:00 - 3:00. This is where double MA systems can really grind your profits down. The MAs just whipsaw back and forth causing three losses in a row, probably evaporating the profits from the first trade. If a person was trading this method on this day, fortunately they wouldve seen one more decent winning trade at 2:30. The good part of this system is displayed on the first trade and the last trade. While moving average crossovers fail miserably during choppy price action, they work very well during trending price action. If you backtest these simple stop and reverse systems, and inspect one that comes out with a profit, youll most likely find that the win is less than 50, but the average winner will be larger than the average loser. Thats because moving average crossover systems are essentially trend trading systems. And, trend trading systems almost always have this characteristic of a small percentage of winners and a good ave. win to ave. loss ratio. In the charts below L Long, S Short and Ex Exit. TRIPLE MOVING AVERAGE CROSSOVER So far the discussion has centered around a stop reverse type system, whereby a signal for an exit, also produces a trade in the opposite direction. But if we introduce a third moving average to the system, there can be a period of neutrality. In other words, no trade takes place -- youre in cash. For this example, were going to use a 3 minute chart and three simple moving averages: 4 sma, 10 sma and 50 sma. The rules are very simple. If the slow line (50 sma) is rising, and the fast line (4 sma) crosses above the middle line (10 sma), there is a buy signal. The exit signal comes when the fast line crosses below the middle line. The rules are the opposite for short entries. Its easy to see, that this system is similar to taking trades off the trend of a higher time frame. An alternative to this system, would be to only take long entries, when both the fast and middle moving averages are above the slow sma. Be aware that when your dealing with three degrees of freedom (3 variables), rather than two as in the above example, you are making the system more complex and therefore creating many more possible combinations to test. Of course, backtesting software makes this a snap, but remember that adding filters and complexity doesnt always make a better system. Frequently, a simpler system can be more robust under testing. An example is below. If youre interested in moving averages, you might also want to check out my page on how to use moving averages as a trailing stop. Arthur Hill On Moving Average Crossovers Arthur Hill On Moving Average Crossovers A popular use for moving averages 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 advances 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 also generate more false signals than systems with longer moving averages. For Inter-Tel (INTL) . a 30100 exponential moving average crossover was used to generate signals. When the 30-day EMA moves above the 100-day EMA, a buy signal is in force. When the 30-day EMA declines below the 100-day EMA, a sell signal is in force. A plot of the 30100 differential is shown below the price chart by using the Percentage Price Oscillator (PPO) set to (30,100,1). When the differential is positive, the 30-day EMA is greater than the 100-day EMA. When it is negative, the 30-day EMA is less than the 100-day EMA. 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. Some good entry points for long positions were caught in Sept-97, Mar-98 and Jul-99. However, an exit strategy based on the moving average crossover would have given back some of those profits. All in all, though, the system would have been profitable for the time period shown. In the example for 3Com (COMS) . a 2060 EMA crossover system was used to generate buy and sell signals. The plot below the price is the 2060 EMA differential, which is shown as a percent and displayed using the Percentage Price Oscillator (PPO) set at (20,60,1). The thin blue lines just 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. Therefore, the buy signal was set just above the zero line (at 2) and the sell signal was set just below the zero line (at -2). When the 20-day EMA is more than 2 above the 60-day EMA, a buy signal is in force. When the 20-day EMA is more than 2 below the 60-day EMA, a sell signal is in force. There were a few good signals, but also a number of whipsaws. Although much would depend on the exact entry and exit points, I believe that a profit could have been made using this system, but not a large profit and probably not enough to justify the risk. The stock failed to hold a trend and tight stop-losses would have been required to lock in profits. A trailing stop or use of the parabolic SAR might have helped lock in profits. Moving average crossover systems can be effective, but should be used in conjunction with other aspects of technical analysis (patterns, candlesticks, momentum, volume, and so on). While it is easy to find a system that worked well in the past, there is no guarantee that it will work in the future.