Moving Average Crossovers: Momentum Versus Mean Reversion

Summary

The document contrasts two interpretations of moving-average crossovers. Under a mean-reversion view, a short-term average below a long-term average may be treated as evidence that price has fallen and could recover. Under a momentum view, a short-term average crossing above a longer-term average can be treated as a breakout signal, with the expectation that the existing direction may continue. Which interpretation seems plausible therefore depends on the market hypothesis behind the rule.

The answer also notes that under weak-form market efficiency, neither condition should be presumed more profitable simply from its definition. It recommends testing the alternatives rather than treating either as a general consensus. No empirical results, assets, lookback periods, or transaction-cost assumptions are provided, so the document frames competing hypotheses rather than establishing an actionable strategy. Any test would need specified rules and data to assess whether apparent performance survives costs and other practical constraints.

Key ideas

• A mean-reversion approach may interpret a short average below a long average as a buying opportunity.
• A momentum approach may treat an upward crossover as a breakout signal.
• The preferred interpretation depends on the assumed behavior of prices.
• Weak-form efficiency gives no reason to assume either crossover state is inherently more profitable.
• Competing crossover rules can be evaluated empirically, with results dependent on test design.

Tags

# Moving Averages Crossover question


# Moving Averages Crossover question












I'm reading on Investopedia that one should buy a stock if short term moving average is ABOVE the long term moving average, since this "indicates an upward trend".

However, this is not intuitive to me. Wouldn't it be more beneficial to buy when the opposite is true? I.e when the short term trend is below the long term trend, since you can expect the market to correct itself and there make a profit.

It's obviously a matter of personal preference, but the latter makes more sense to me. What's the general consensus?

## Answer by Andrew (score 1)

https://quant.stackexchange.com/a/21787

Under weak-form efficient markets neither situation is more profitable to buy in.

Contrarily, under technical analysis, the answer depends on whether you adhere to a mean-reverting or a momentum theory of the market. Under the former, your supposition is correct. Under the latter, certain shorter-term MAs crossing certain longer-term MAs from below are deemed to be breakouts. Exact cases vary in the literature.

The best thing is, all of these theories are easily testable.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.