The crossover signal is one of the most simple signals you’ll need to assist with your CFD trading. There are also several variants of the crossover law, which we will discuss here.
The simplest rule of crossover is when the price goes above a certain level. This may be an area of significant resistance, and that suggests a breakthrough for the market to pass and potential continued increasing prices. This is not a crossover’s normal sense, so it’s the easiest.
The next form of crossover is where the stock chart has a moving average, and the stock crosses over the moving average. In this case, the moving average is relatively short-term, say a 10-day moving average (SMA10), and therefore tends to follow the trend fairly closely. If the market changes direction, from a downward trend to an uptrend, or vice versa, the price goes beyond the norm. In this case, the crossover rule states that you should buy if the price exceeds the average line and sell (or go short) if the price drops below.
It’s easy to see that that would usually help you invest in an uptrend and sell as it turns to a downtrend, and that’s a simple way to make sure you’re going in the correct direction because you’ve got a trending market, too, isn’t that unpredictable. Yet this approach will give rise to too many signals because the price does not shift seamlessly in reality, and you can get ‘right’ signals that easily prove incorrect. You can deal with that by adding in a time limit, meaning the price needs to sit above or below for a couple of days after crossing, but because this slows the trade, you will miss part with every pass.
In this crossover process, the reason you get false signals is that the price will often jump away from the general market shift. Now, if you’re selling differential futures, you’re going to be especially nervous about this, as the risks are leveraged. You want the best opportunity just to make successful trades. The answer is not to use the price but another line that follows the price without spikes being generated. Such a line is a running average in the short term.
This leads to the crossover method of two moving averages. In this case, you have two moving averages of the different number of days, and when these lines touch one another, you swap. The moving averages (SMA5 & SMA20) can usually use five days and twenty days. When the average moving shorter period rises above the longer, that is a signal to enter into a long trade. When it drops below, you’re selling your position, and if that’s your trading style, you’re going to go short too.
The two methods of moving average convergence can help to minimize the number of bogus trades taken. The price for this reliability is that it is less sensitive and will lag beyond the single moving average crossover, but that is a price worth paying to avoid drawdowns.