Swing traders use many indicators to help them assess potential trade opportunities. Moving averages – both Simple and Exponential – are among the most popular and effective when developing a trading strategy.
Today’s charting software makes it easy to display moving averages as lines on our charts, and they can help us to identify trends, likely areas of support and resistance, and even reversal points.
In essence, a Simple Moving Average (SMA) is an expression of the average closing price of a financial instrument over a particular number of periods. Any number of time periods can be used, but the 5, 10, 20, 50, 100, and 200, are among the most popular.
Each ‘period’ represents a period of time, for example, 5 minutes, 10 minutes, 2 hours, etc. but for swing traders, each period will likely be 4 hours or one even one trading day.
While the calculation of the EMA can be a little complicated, fortunately, our software will perform them for us instantly and automatically. The key takeaway is that EMAs are likely to give us a better indication of the current direction and strength of a trend than SMAs. And the fewer periods used, the more sensitive the picture will be to recent market sentiment.
Whether we are using SMAs or EMAs, the key idea underpinning the crossover strategy is the same. When a shorter-term moving average line crosses a longer-term line, it may be an indication that an existing trend is accelerating or that it is losing momentum or about to reverse.
And we can tell which it is by looking at the direction of the cross and the existing trend. An upward cross in a bull trend, for example, indicates a strengthening trend. But in a downtrend, it may signal a forthcoming consolidation or even a reversal.