Moving Average Cross Over Systems – Do They Work?

Moving Average Cross Over Systems – Do They Work?

Moving average cross over systems are usually one of the first indicator based trading systems that forex traders come across in their quest to learn how to trade the forex market. Moving averages do indeed have a useful place in any forex trader’s toolbox. However, many traders use them the wrong way by following them mechanically through the implementation of the moving average cross over system. Blindly entering the market based on the cross-over of an 8 and 21 period EMA (exponential moving average) is a very popular trading system that some scammers and internet marketers try to sell to aspiring forex traders. There are many variations of such moving average cross over systems, the 8 and 21 will be used here for illustrative purposes.

While it is true that sometimes the moving average cross over entry will work, there are also many times where it simply does not work, and it is these times that cause forex traders to give back most or all of their profits. The common way to trade the moving average cross over is by waiting for the faster moving average (8 period EMA in our example) to cross above or below the slower (21 period EMA in our example), and once this cross-over happens you then enter a trade in the direction of the cross. Let’s take a look at a chart example to make this clearer:

Notice in the chart above of the 4 hr GBPJPY pair, the entry signal is the cross-over of the 8 period EMA above the 21 period EMA. Typically in moving average cross over systems the exit signal occurs when the fast EMA (8) crosses back under the slower EMA (21).

So we can see in the above chart that there certainly are times when the moving average cross over system does work. However, market conditions must be moving and trending well for such cross-over systems to work consistently. What happens during consolidation periods when the market is simply moving sideways in a choppy trading range? Unfortunately for traders who mechanically trade moving average cross over systems, such consolidation periods can literally destroy their trading accounts. This is because in a consolidating market as soon as the moving averages have crossed and fired an entry signal, the market is about ready to reverse and head in the opposite direction. Let’s take a look at the 4 hr GBPJPY again to illustrate this concept:

In the chart above of 4 hr GBPJPY we can see a crossover of the 8 and 21 EMA at each red arrow. This means if you were mechanically trading a moving average cross over system here you would have to enter into a trade at each crossover while exiting the last one. One major fact of moving average cross over systems that many traders don’t realize is that by the time the actual cross-over of moving averages occurs, price is well above or below the moving averages. This means you are going to be entering or exiting at a much different price than where the moving average cross over actually occurs.

Because the candle must close out before the cross-over takes place, price can sometimes be 100 pips or more above or below the cross-over price. This means in conditions like the chart example above, you are going to lose on every single mechanical cross over entry. This is the main problem with mechanically trading a moving average cross over system; you are going to have far more losers than winners and thus it is going to be extremely hard to come back. In the example above you would have endured 6 losing trades in a row before the final cross over on the far right which may have netted you some positive pips.

Moving averages do have their place in the world of forex trading systems, however blindly following a moving average cross over system is a flawed system and using moving averages in a mechanical fashion is useless. Where moving averages are useful is in highlighting areas of dynamic support and resistance, you can use moving averages to look for confluent areas in the forex market. These are areas where multiple signals are coming together in combination. We will discuss this topic further in another educational article.