Can Moving Averages Be Used to Forecast Price Direction?

In a single word: No.

I often hear of or read the comment that analysts use moving averages to predict price direction and even the next close. I started my career as a technical analyst way back when I was working in Hong Kong and my treasurer sent me on a technical analysis seminar where I learned about golden crosses and dead crosses. In particular, stated the presenter, use a 20 days and 60 average to represent a 1 month and 3 month average.

"Great!" thought I, "this is going to make my life easier. I can't wait to get back into the dealing room to try this out."

In those days the fashion was to draw your own charts to get a better "feel" for the market and thus I used to draw the averages on large charts stuck to the wall.

What a waste of time…

Every time the 20 days average crossed above the 60 days average price reversed lower.

OK. Then throw average out of the window… Since that time I have never used averages in my analysis again.

That was around 1989-1990 just as real time technical analysis systems started appearing in trading rooms. Over the 1990's I became interested in building systems and it was around the mid 90's that I kept hearing this statement about how moving averages predict price.

Well, using a programmable technical analysis software I set up the software to write a report for me that summarized the close to close profit or loss generated from using the underlying moving average direction. Hence, when the moving average was rising I would then measure the profit or loss generated from close to close over the next day, and vice versa when the average was declining. Which average did I use? For the sake of simplicity I used the market favorite, the 20 period moving average used by the fund management industry.

The following are the results for six currency pairs showing the average profit & loss and the percentage of winning trades:

Note that in all cases the average profit is not any higher than the bid-ask spread and mostly lower. This doesn't really give me any confidence in using a moving average to predict the next day's close to close movement.

The moral of the story? Don't expect too much from your indicators. There is nothing magic about any of them in providing anything but circumstantial supporting evidence of a trade. All indicators, whatever the creator's claim, are lagging indicators since they are based off historic prices and therefore reflect what has been and not what will be. They can provide you with information about the general characteristic of price action at that time but the real information you require is all in price and it is in the understanding of price and trading mentality that will help you pick better trades.