Moving Average Crossovers

One of the main things that a Chief Market Strategist notices, especially coming from a technical analysis background, is how complicated many Blue Index clients and other traders make their trading. There are the fundamental traders who seemingly have AFX news on an intravenous drip - and hence suffer from information overload.

But, it is perhaps the technical traders that are even worse, enquiring where all the near term moving averages are, Elliott Waves, Fibonacci retracement levels, RSI and Commodity Channel Index. They understandably do not know what to do.

The main problem with all this information is that in markets that move much faster than they used to because of the internet, the brain simply cannot cope. This would present a problem even for a casual observer trying to analyse. But, if you have money on the line and are emotionally attached to a position, it is not an exaggeration to say that your IQ is effectively halved. A near-term move against you can mean that instead of being a rational trader, you are a quivering mass of jelly.  Obviously, having a pre-planned strategy is the answer here, but what should it be based upon?

There are a few fundamental based strategies that could be used successfully. Buying a few weeks before a major trading statement. Buying ahead or even just after the ex dividend date, or even shorting after the first profits warning. An interesting approach in current stock market conditions when there is very often a run up before a trading statement would be to go long the day after a company report. By this time the hot money has had plenty of time to get out and any negative press comment is in the price. However, this is by no means a clear cut method of trading and it is in the realm of technical analysis that trading strategies and signals come into their own.

The following examples of high profile stocks illustrate this point. One of the big names of the past year since it came to the US stock market has been Google (GOOG), the internet search engine. Many traders have fretted over the turning points in the shares. But as can be seen from the 10 day and 20 day moving average crossovers on the daily chart, if you have followed these signals it could have been highly profitable. The idea behind moving average crossovers is that when the shorter term average (10 day in purple) crosses above or below the longer period average (20 days in black), we are possibly witnessing a change of trend as recent prices start to either lag historical ones in a bear move or vice versa in a bull situation. You trade the signals back to back so that you always have a position.

On the Google chart there have only been three crossovers since February, first down in that month, up in April and then down at the beginning of this month. The first two signals bought and sold at close to the same level at $195. However, the buy in April at $195 was closed out this month in the $295 area with a notional profit of $100. All you had to do was run the buy position until the moving averages crossed down. The only catch is that your stop loss is the moving average cross.

Vodafone (VOD) shows similar flat cross in the April to July period, but the last crossover up in July at 138p is currently 12p in profit. We await the crossover down to reverse and go short.

Finally, just to prove that moving average crossovers are not just about historical events, the chart of Billiton (BLT) shows the 10 day moving average just about to cross below the 20 day line. One down day should be enough to extract a clear crossover and one would be going short in the 800p - 810p area. If the cross occurs, a trader long from the beginning of June would have netted near 150p from the crossover buy.

A point worth remembering, the stronger the trend, the better moving averages work. Therefore, gold and oil stocks are particularly suited to this system of trading.

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