Although there are almost countless improvised, and professionally created strategies based on moving averages, there are three typical methods that lie at the basis of most of the strategies and methods.
Crossovers arise when the price rises or falls below the moving average, signaling the end or the beginning of a new trend. Crossovers are some of the most common occurrences in technical trading, and as such, do not grant us a great deal of predictive power in the evaluation of the market action. They are used best in combination with other tools and techniques when we seek to evaluate the price action with greater confidence.
Apart from trends in the price action itself, the moving average can also have its own trend at times. It is possible to take advantage of these trends for determining entry/exit points. Although not as reliable as the price trend itself when used alone, it can be an efficient way to confirm the price action when used in combination with it.
A divergence occurs when the trend is in ascendance, but the moving average is descending. A convergence happens when the market trend is bearish, but the moving average contradicts it by registering higher highs. These events are thought to signal a future reversal. When the price action is contradicted by the indicator values, the expectation is that the market is about to run out of energy, and it may be a good time to open a counter-trend position. It is important to remember that timing is very uncertain in all these formations, and that the anticipated reversal may never occur. Especially in strong trends, it is common to observe divergence/convergence phenomenon arise regularly without leading to any significant reversal. Still, it is the rarest, and most popular technical configuration preferred in the interpretation of a moving average.
We use this term to define a method of trading in which MAs of different periods are used as successive resistance levels for the price action to breach. For example, we expect an ongoing trend to first breach the 1-hour, then the 3-hour, then the 10, and 40-hour moving averages in succession, and may choose to open a position at each of these successive indicators. Since we anticipate continuity between levels indicated by these MAs, we will maintain our positions as the price hops, so to speak, between them.
We'll examine each of these methods as we discuss each moving average type in its own article. To learn more about how these calculations are performed you are invited to visit the relevant page.
The main weakness of the moving average is its lagged nature. In many cases, and especially for short term fluctuations, by the time a moving average captures a market event, it may have already ended. The moving average will only note a developing market pattern after it has been set up convincingly, and if the pattern is short-lived, it will not be possible to trade it, and we may suffer from whipsaws as well.
The strength of this indicator type is its ease-of-use, clarity, and simplicity. They can be easily incorporated into any overall strategy, and it is also possible to devise methods exclusively through the usage of the moving average as well. The great versatility of this indicator type makes it a valuable addition to any trader's arsenal of technical tools, regardless of trading style, or the preferred market type.