Ask Colin

Is trading crossovers of the 260-day moving average a good system?

The 260-day moving average is quite a good proxy for trend on a medium term basis and would be used by an investor rather than a trader, though it depends how you define those terms.

However, that said, there is a huge caveat: a moving average is a trend following indicator. It works best in strong trends. When you do not get a strong trend, it can be a very expensive way to invest. What happens in the absence of a strong trend is that we see the price flipping back and forth across the moving average, taking us in and out of the market, often at a loss.

The other problem with moving averages is that if we trade the crossovers by price, there will tend to be some excursions across the moving average at times, even in good trends. It requires extreme discipline to buy back into the trends in these situations.

So, yes, the 260-day moving average can be traded as you suggest, but it will require great discipline and if the stocks you choose do not trend well, you will tend to lose. You can back-test it quite easily using computerised charting packages. You can also paper trade it and visually inspect hundreds of charts. Of course, the usual caveat applies: there is no guarantee that the future will be like the past. If the immediate future turns out to be a sideways market, you could give up on a moving average before it has time to work in the right markets.

I only use the moving average to help me see the overall trend direction from whether the moving average is sloping up or down.