Valid Moving Average Crossover

There are a lot of whipsaw or false signals, how can we tell which ones are going to be a valid moving average crossover?

A crossover is any penetration of an Moving Average. However, close observation of any chart featuring an Moving Average will usually reveal a number of whipsaw, or false, signals. How can we tell which ones are going to be valid? Unfortunately, there is no way of knowing for certain. Indeed, many whipsaws cannot be avoided and should be regarded as a fact of life. However, it is possible to avoid some of these close calls by using filtering techniques.

The type of filter to be used depends on the time span in question and is very much a matter of individual experimentation. For example, we may decide to take action on MA crossovers for which a 3 percent penetration takes place and to ignore all others. Violations of a 40-week MA might result in an average price move of 15 to 20 percent. In this instance, a 3 percent penetration would be a reasonable filter. Some analysts, recognizing that one-period whipsaws are quite common, require an MA crossover to hold for at least one period. In the case of daily.

If an Moving Average crossover takes place at the same time a trendline is violated or a price pattern completed, these signals strongly reinforce each other and therefore need less in the form of a filter requirement data, this approach would mean waiting for the second or third day before concluding that the average had been violated. A more sensible method is to use a combination of the period and percentage penetration for deciding whether a crossover is valid.

Moving Averages are usually constructed from closing price data. Closing prices are more reliable than highs, lows, or openings because they reflect positions that investors are willing to carry overnight or, in the case of weekly charts, over the weekend. Intraday trading can be subject to manipulation or distorted by an unwarranted emotional attitude to news events. For this reason, it is best to wait for the closing price to penetrate the average before concluding that a crossover has taken place. If intra-period activity is used for Moving Average violations, it is usually best to calculate an MA based on daily lows or highs.

One exception would occur when a bar chart touches an Moving Average on numerous occasions. In many instances, the Moving Average is clearly a significant support/resistance point and its violation should be treated with respect.