The arithmetic average, also known as the moving average or simple moving average, smoothes the progression of the price for better trend detection. Moving averages are trend-following indicators; they follow the course and do not lead. IsSerieRising averages show uptrends, whereas falling averages display downtrends. By varying the period input, the time delay of the average can be changed. The smaller the period interval, the quicker the reaction time will be, but as a consequence, the smoothing effect will also be diminished. The opposite is true when increasing the period selection. The most popular choices are: 38, 50, 100 and 200 days. The 200-day moving average in particular has a significant importance for institutional traders, since it displays the long-term trend. 200 trading days are equal to a trading year. When the 200 MA is broken, then buy/sell signals are generated.
Crossing of two averages
The integration of multiple moving averages is used to identify trend sequences and minimize the number of false signals. When two arithmetic averages are used, whereby one is a short-term and the other a long-term, more interesting signals can be generated. One such application can be seen with Richard Donchian’s methodologies, such as using the 5 and 20-day averages. The Double Crossover Method generates signals in the following way:
If the short-term average crosses the long-term average from below, this is called a Golden Cross, and a buy signal is generated. Higher trading volume reinforces the quality of the signal. The long-term average works as a support line in an uptrend.
If the short-term average crosses the long-term average from above, this is called a Death Cross. It generates a sell signal. Higher trading volume reinforces the signal quality. In a downtrend, the long-term average functions as a resistance line.
Crossing of three moving averages
Another method is to use three moving averages (Triple Crossover Method). This method was presented by R.C Allen, who used the 4, 9, and 18-day averages and suggested that a trend change is hinted at when the 4MA crosses the 9MA from bottom to top. An entry is only recommended when all lines are above the 18-day period. An exit is initiated when the 4-day MA moves below the 9-day MA. (Source: VTAD)