Moving average crossovers
When a fast average crosses a slow one, what traders read into it, and why it's always late.
Two lines, one signal
Put two moving averages on the same chart: a fast one (short, like 50 days) and a slow one (long, like 200 days). When the fast line crosses the slow line, that's a .
Why would that matter? The fast line shows what price has done lately. The slow line shows what price has done over a long time. When recent prices climb above the long-run average, the trend may be turning up.
- Fast crosses above slow: a possible start of an uptrend.
- Fast crosses below slow: a possible start of a downtrend.
The famous ones
Two crossovers have their own names, and you might hear them on the news:
- : the 50-day average crosses above the 200-day.
- : the 50-day average crosses below the 200-day.
They sound dramatic. They're really just two averages crossing.
A crossover with tiny numbers
Let's use a fast 2-day average and a slow 4-day average. The closes are $12, $10, $9, $8, $11 and $13.
- Day 4: fast = (9 + 8) ÷ 2 = 8.50. Slow = (12 + 10 + 9 + 8) ÷ 4 = 9.75. Fast is below slow.
- Day 5: fast = (8 + 11) ÷ 2 = 9.50. Slow = (10 + 9 + 8 + 11) ÷ 4 = 9.50. They touch.
- Day 6: fast = (11 + 13) ÷ 2 = 12. Slow = (9 + 8 + 11 + 13) ÷ 4 = 10.25. Fast is above slow. Crossover!
Now look back. The lowest close was $8, on day 4. By the time the crossover showed up on day 6, price had already bounced all the way to $13. The signal was late.
Why it's always late
A slow average takes many days to turn, so the cross only happens after price has already moved a good amount. In the drawing, price topped out several candles before the fast line crossed below the slow one. Anyone waiting for that cross gave back a chunk of the move first.
Traders accept this on purpose. A crossover isn't trying to catch the exact top or bottom. It tries to catch the big middle part of a long trend and skip the small wiggles.
Where it fails
When the market goes sideways, the two lines tangle and cross over and over. Each cross looks like a new signal, and one after another fails. Traders call this getting , named after a saw that cuts back and forth. One big trend can make up for several small whipsaw losses, but only if a trend actually shows up.
Golden crosses that came right before a drop, and death crosses that came right before a rally, have both happened many times.
Remember
- A crossover is a fast average crossing a slow one.
- Golden cross: 50-day crosses above the 200-day. Death cross: 50-day crosses below it.
- Crossovers are always late, because averages are built from the past.
- In sideways markets they flip back and forth and lose.
Check yourself
1. What is a golden cross?
2. Why does a crossover show up after the real top or bottom?
3. What does it mean to get whipsawed?
4. The fast average is $12 and the slow average is $10.25. Where is the fast line?
Next lesson: Bollinger Bands
Money Tree School is education, not financial advice. Examples use made-up or historical numbers to show how things work; they are not recommendations to buy or sell anything. Markets can lose money.