The use of two moving averages (MAs) provides useful confirming signals. However, they do not often serve as leading indicators. By definition, the MA is a reflection of price, thus is follows and only confirms what other signals reveal.
The general rule in using two Mas is that when the faster MA crosses above the slower, it is bullish; and when it crosses below, it is bearish.
A good example of this is found on the chart of Haliburton (HAL).
The first noteworthy signal is the bullish piercing lines, marking a reversal point in a minor and short-lived bearish trend. Because this reversal was not especially strong, it required confirmation before entering a trade.
Confirmation occurred with the appearance of two signals. First was the bullish crossover, in which the 50MA crosses above the 200MA. Second was the volume spike, occurring at the same point on the chart.
Once price peaked at the beginning of May, a one-week retracement followed. This could have been yet another turning point or only a pause. The final answer occurred when the upside tasuki gap showed up. This is a bullish continuation signal, forecasting further bullish moves.
This example demonstrates the value and the limitation of MA convergence and crossover. As the two lines began to converge during April, the indication was that the bullish piercing lines was a legitimate bullish reversal. The crossover plus volume spike confirmed this.
The overall value of crossover as a lagging indicator is most important in charts such as this. The trend was weak and uncertain during March and April, and only with confirmation was the bullish nature of price behavior made clear. The continuation signal appearing at mid-May was accompanied as the two MA lines began moving away from the convergence point. The resulting rise in the 50MA provided a form of dynamic support, further confirming the continuation of the bullish trend.
Michael Thomsett blogs at TheStreet.com, Seeking Alpha, and several other sites. He has been trading options for 35 years and has published books with Palgrave Macmillan, Wiley, FT Press and Amacom, among others. His latest book is tinyurl.com/z44kzlu
