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Trend following with moving averages

Ride the big moves and step aside in bear markets. How a simple moving-average system works and what to check before trusting a signal.

· 2 min read

Trend following with two moving averagesA fast moving average crosses above a slow one near the start of an uptrend, and back below it after the top. Fast MA Slow MA Cross up: enter Cross down: exit
Two moving averages: enter when the fast one crosses above the slow one, exit when it crosses back below. Illustration with simulated prices.

Key takeaways

  • Trend following buys after a trend starts and exits after it ends. It never catches tops or bottoms.
  • Expect to lose on more than half of trades; a few long trends pay for them.
  • Write the rules down, act only on closed daily candles, and don't change them after a losing streak.
In this article
  1. A simple system
  2. Why it feels bad and still works
  3. What to check

Trend following does not try to predict tops or bottoms. It buys after a trend is already underway, holds while it lasts, and gets out when it ends. Crypto's trends tend to run long, which is why this old idea from futures markets suits it well.

A simple system

The classic version uses two exponential moving averages (EMAs) on the daily chart:

  • Entry: the 50-day EMA crosses above the 200-day EMA, often called a “golden cross”.
  • Exit: a daily close below the 50-day EMA, or the 50 crossing back below the 200.

Faster pairs such as 20/50 react sooner but give more false signals in choppy markets. Slower pairs such as 50/200 are calmer but give back more profit when the trend turns. There is no best setting, only one that you will actually stick with.

Why it feels bad and still works

Trend-following systems often lose on more than half of their trades. In sideways markets they get chopped up with small losses. Then a real trend arrives and one trade makes back all of those losses and more. The trouble is that most people abandon the system during the choppy stretch, just before the payoff.

Strengths

  • Clear, mechanical rules.
  • Easy to test on past data.
  • Keeps you out of most of a bear market.

Weaknesses

  • Whipsaws in sideways markets.
  • Low win rate.
  • Late in, late out, by design.
A sideways market whipsaws a crossover systemWith no trend, the fast and slow moving averages cross back and forth, and each signal turns into a small loss. Fast MA Slow MA 8 crosses, no trend: each one a small loss
The cost of trend following: in a sideways market the averages keep crossing, and each signal becomes a small loss. Illustration with simulated prices.

What to check

  1. Are your rules written down? Which averages, which timeframe, what counts as entry and what counts as exit. A trend system only works if it is followed mechanically, and you cannot follow rules that live only in your head.
  2. Did you test them? Look at how your rules would have done over at least the last two market cycles, including a bear market. Count the losing streaks, not just the total profit. If a run of eight small losses would make you quit, choose different rules.
  3. Did the signal happen on a closed candle? Moving averages can cross during the day and uncross by the close. Act only on signals from finished daily candles. This alone removes many false starts.
  4. Is price stretched? If price is already 25% or more above the fast average when the signal fires, much of the move may be done. Many trend followers wait for a pullback toward the average before entering.
  5. Is the market trending at all? When both averages are flat and price keeps crossing them, the market is ranging and a trend system will bleed. Some traders add a filter, such as only taking signals when the slow average is sloping up.
  6. Is the position sized for your stop? Trend stops are wide because they sit at the moving average or the last swing low. Size the position so that hitting that stop costs no more than your usual risk per trade.
  7. Are you checking too often? A daily system needs one look a day, at the close. Watching the 5-minute chart while running a daily trend system mostly produces the urge to break your own rules.

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