The moving average crossover is probably the most widely known trading strategy to the general public. It is documented in literally thousands of technical analysis books, used by the famous Turtle traders and mentioned countless times on mainstream financial media – yet it is fundamentally flawed in today’s markets.
The main problem is its a “reactive” rather than “predictive” way of trading. The method assumes that momentum will continue after a crossover with no thought to the current conditions of the market.
The 50/200 Crossover
Probably the most famous of the crossovers are the “death cross” and “golden cross”. Simply put, we are told to sell when the death cross occurs (which is the 50 day moving average crossing down below the 200 MA) and buy when the golden cross occurs (the 50 day moving average crossing up above the 200 MA).
The following chart shows the 50 and 200 moving averages crossing on a daily GBPUSD chart. The yellow dots indicate where the crossovers occurred. At first sight it looks like this might be a great strategy…
However the above chart is very deceiving. Let’s look at the same chart, but this time I have added vertical lines to project where the price actually was when the MAs crossed. The red circles indicate the earliest opportunity you could have entered each trade. On most occasions the entries were a long way from the crossover signals. In one case, the crossover would have caused you to enter at the worst possible time!
Moving average crossovers will work in strong trending markets, but the above ranging price action is more typical of the markets nowadays, where retail traders often get chopped up.
Let’s visit a zoomed in segment of that chart again, but this time I’ll add some supply and demand zones.
Suddenly the picture starts to get a lot clearer. We have a very good idea of where price may bounce – at a return to an area where there are institutional buyers or sellers. Compare that to the very late entries provided by the MA crossovers. The MA crossover is espoused by the same camp who believe “the trend is your friend” and you shouldn’t trade reversals because it’s equivalent to “catching a falling knife”. These blanket phrases are meaningless without applying them to the context of the current market action.
The problems that plague moving averages can be applied to indicators in general. However complex or craftily coded they may be, no indicator can predict the future of the market – they all follow price!
And remember… these markets (especially Forex and Crypto) range a great deal of the time. It’s during these periods that traders will hand back most (or all) of their hard earned gains. This is when indicators are likely to give one false signal after another leading to traders emptying their accounts
Of course, supply and demand zones are not infallible. There are reasons why some fail and some work better than others. To really do well at supply and demand trading, you must understand bias, market structure and the advanced techniques that I teach right here.
So what to do now with that pile of technical analysis indicator books that are gathering dust on the shelf? I’ll let you decide 😉 but you’ll be amazed how easier trading becomes once you clear those indicators off your charts!
If this article switched on a few “lightbulbs” for you, please pass it on with the social media buttons below. Thank you!