- The most important signal that reflects the direction of a trend is the general direction of an MA movement. With a rising moving average, a chartist would take a bullish approach, attempting to profit from a rise. Buy when prices edge down to the MA, placing a stop order below the previous low and moving it as soon as the price closes below the earlier level. A falling MA means that prices are heading lower in a bearish market. In this case, open short positions whenever prices rise to the MA or anywhere higher. Place a stop order slightly above the previous peak and move it dynamically if the downward trend remains in place.
- The second signal to take into account is the crossover of a moving average and the price. This is the strongest signal indicating that a new bullish trend is emerging if an MA crosses the price chart from top to bottom with an upward slope, and the price chart also has a large upward slope. Another type of crossover occurs when a moving average with a downward slope crosses through the price sloping downwards or upwards. Such a crossover gives a weaker signal for an upcoming bullish trend. In this case, you need an additional signal to confirm further market dynamics. Similar signals with opposite slopes should be interpreted as signs of an upcoming bearish market.
- The third signal is a reversal of an MA at the highest or lowest price. If a moving average is located below the price chart and has an intraday low while the price chart has an upward slope, it sends a moderate buy signal indicating the presence of a bullish trend. If the price chart does not have an upward slope, a moving average sends a very weak signal. It takes three additional signals to confirm it.
These rules can be applied to trending markets. In a trendless market, such lines will be curved. A trader’s attempts to smooth out these curves manually usually lead to a loss of a useful signal.
You can see three types of moving averages on the chart. The crossover of the market price and the indicator at the bottom gives a buy signal.