Moving Average (5): Graphically Speaking
Figure 1 is the chart of the price, 5-day and 15-day moving averages when the price is going up. The closing price is the blue line, and the 5-day and 15-day moving averages are the red and green lines, respectively. The first thing we note is that the moving average lines are below the price line. This is not surprising because moving averages are averages of past data, so if the price is increasing, the moving average will also be increasing but in a slower pace because it is lagging behind. You can also see that the 15-day moving average is lagging even more and so the 15-day moving average is below both the price and the 5-day moving average.
Fig. 1 Price, 5-day and 15-day moving averages with price going up
The next chart is a chart when the price is going down (figure 2). Quite naturally the opposite from above is true: the moving averages are above the price line, and the 15-day MA is above both the price and the 5-day MA.
Fig. 2 Price, 5-day and 15-day moving averages with price going down
Fig. 3 Price, 5-day and 15-day moving averages with price changing direction
And that crossover is the famous (should have been and should be called the infamous) use of single moving average. What is happening here is since the price HAS CHANGED direction, the moving average line FOLLOWS and so it crosses the price line. But what is always or very often suggested is that since the moving average crosses the price line, the price must be changing direction. That is a logical fallacy!
The exact same thing is happening with the 2 moving averages. When the price is increasing, the 5-day MA (moving average) is above the 15-day MA. When the price is decreasing, the 5-day MA will become below the 15-day MA. That means at some point the two average lines must cross, and here is another famous (should have been and should be called the infamous) use of two moving average.
The same fallacy is occuring here as well. The changing direction of the price HAS CAUSED the 2 moving averages to crossover. What is often incorrectly suggested is, however, that the crossover of the two moving average suggests that the price will change direction. The crossover does tell that the price HAS changed direction, but whether the trend will continue cannot be predicted by the crossover.