1. Trend Following
Approximately 30% of the time, a security or exchange rate will trend. A trend is a pattern that perpetuates and moves in the same direction until the trend concludes. There is a saying: “The trend is your friend” which means that it is easier to make money when a security is trending compared to attempting to fight the trend and make money when a security is consolidating. There are several indicators you can use to determine if a security is trending. One of the best indicators is the moving average crossover.
A moving average is the average of a specific number of price points. For example, a 5-day moving average is created by using the average of the last five daily closes. On the sixth day, the first day is dropped from the average and this continues. You can use a daily closing price, the high of the day, the low of the day or even weekly or monthly closes to create an average.
One of the most popular trend-following strategies is the moving average crossover strategy. This occurs when a short term moving average crosses above or below a longer-term moving average. In the chart below of the USD/JPY, the 5-day moving average and the 20-day moving average are plotted. When the 5-day moving average crosses above the 20-day moving average, a buy signal is generated (green arrows).
When the 5-day moving average crosses below the 20-day moving average, a sell signal is generated (red arrows). The moving average crossover tells you when a short-term trend is occurring. This indicator generally points to the middle of a short-term trend. If you want to capture a longer trend, you can use longer moving averages.