Like we said, a Moving Average follows the price movement on a chart because it is a lagging indicator. If the moving average is rising and price tends to move above the moving average, this is considered an uptrend.
When the moving average is falling and price moves below the moving average, it is a downtrend.
As the moving average line gets closer or crosses through the price trend, it indicates a probable change in trend direction, therefore expect a possible reversal or just a pause in price movement.
To avoid false signals, traders use several moving averages on the chart e.g. Combination of the simple moving average and exponential at the same time. One is faster than the other therefore it becomes easier to identify if it is a fake out signal or real.
Let’s take a look at the chart below;
Taking a look at the above market chart, we are using the two moving averages. Price is trending upwards and the faster moving average is above the slower moving average while for a down-trend, the reverse is true. The faster moving average moves almost at the same pace as price as the slower lags behind them.
When price crosses the faster moving average, it is likely to be a fake out. As the slower moving average approaches the faster moving average and price moves closer to the two moving averages, its a strong signal for change in trend. The crossover of the two moving averages would be a good signal to enter trade.
When the market is in an uptrend, the faster moving average tends to diverge from the slower moving average at a wide distance indicating a rise in momentum. The same happens for a downtrend.
But when the two moving averages converge/contract, price tends to pull back indicating a slow down in momentum. This gives you a warning in case you are holding any running trade to prepare to exit or tighten your stop loss.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...