Many forex traders who have tried using moving average crossovers to time their entry into a trade have probably found them to have limited value as they have a tendency to signal an entry late in the move. If you are buying late, you find that too often you buy near a short-term top or if you sell late, you find that too often you sell near a short-term bottom.
This would not be so bad in a strong trending market, but the real damage is done in a directionless market where there are many crossovers with no follow-through which can mean losing trade after losing trade. The key to use moving average crossovers is to first identify the trend of the market and then to only trade in that same direction. If you find a strong uptrend, then using a moving average crossover as a buy signal has more value.
If you find a strong downtrend, then using a moving average crossover as a sell signal also has more value. Since moving averages can help identify the trend of the market, we can develop a simple trading approach using three different moving averages. This is a daily chart of the EUR/USD with one year of activity. The green line is a 200-day simple moving average. When the market is above this moving average we can consider the trend as up and only take the buys.
When the market is below this moving average, we can consider the trend as down and only take the sells. We are also using a 10-day simple moving average which is the black line and a 25-day simple moving average which is the purple line. When the fast moving average (the 10-day or black line) crosses from below to above the slow moving average (the 25-day or purple line), a buy signal is given.
We can see that there were three crossovers on the chart below and that the market continued to move in the direction of the trend after the crossover. The key here is to first identify the trend and to only trade the strong trends to increase your chance of success.
