User login
Google Search
Syndicate
Investment Lessons - Lesson 4 - Technical Analysis
Moving Averages
In our first lessons, we studied trendlines, and their use.
In this lesson, we will begin to discuss moving averages, and how these can be applied to trendlines to get a better view of market movement.
A moving average is the average of the prices of a security during a given period of time.
Look at the following prices:
| Price | Cumulative Price | Days | Moving Average | |
| 1 | 30.75 | 30.75 | 1 | 30.75 |
| 2 | 31.25 | 62.00 | 2 | 31.00 |
| 3 | 31.75 | 93.75 | 3 | 31.25 |
| 4 | 32.25 | 126.00 | 4 | 31.50 |
| 5 | 31.75 | 157.75 | 5 | 31.55 |
| 6 | 31.50 | 189.25 | 6 | 31.54 |
To maintain a simple moving average, one simply adds the prices of the number of days under study, and averages them for each day of the study.
Simple moving averages demonstrate a smoothing of the price data over a given period of time. They also help in measuring the trend of the security, based on the fact that an average will not move as markedly as the prices themselves.
The most popular moving averages in use today are the 50-day and 200 day. The 200-day represents a long-term average and the 50-day an intermediate term average. These moving averages, when applied to a chart, help the investor confirm the trend of the market, and give additional support to any decision making regarding the movement of funds.
Here, we will bring back our chart of the S&P 500 index, but this time, we will apply a 50-day and a 200-day moving average to the chart.
View Full Size
The 50 day moving average is shown here in dark blue, while the 200 day moving average is shown in yellow.
From April until early September, prices remained significantly above the 200-day moving average. Then, in mid-September, prices plunged below the 200 day moving average and remained there as of March 9, 2001.
So here we have a rule:
Prices rising or falling with force across the 200 day moving average are either extremely bearish or extremely bullish, depending on the primary trend of the market. The move should cross sufficiently, by at least 1% of the value of the 200-day moving average, to be significant.
Looking at the 50 day moving average, we see that this average was crossed and touched numerous times in the period from April 1 until mid-September, when prices then crossed the 50 day and fell significantly before recovering, when the prices began to rise again.
Then, on November 3 of 2000, the 50-day average fell below the 200 day moving average with substantial force, at around 1420.
Another rule to remember:
When the 50-day moving average crosses the 200-day moving average, with significance, it is time to take action on the security you are following.
Based on the primary trend of the market, which was down, and the intermediate trend, which was down, and the fact that the 50 day moving average crossed the 200 day moving average with significance, an investor in the S&P index would have wanted to sell shares there, and go to an account like a money market account, or a bond fund, where the primary trend was up.
By following the technical signals closely, the plan participant can avoid some heavy losses, and stay invested in assets where the primary trend is in their favor.