A moving average is simply an average of certain number of days. For example - if one wants to calculate 10 day moving average, one would take the last ten day's closing prices, add them together and then divide by ten. It is also called simple m
oving average. It is a trend following indicator. It tells a market watcher whether a stock/market is in uptrend or downtrend. Example - When a faster moving average (shorter time frame) is above slower moving average (longer time frame), then we say a stock is in uptrend; and vice versa.
Moving averages apart from indicating trend have also been pretty good at indicating reversals. For example, when a stock refuses to take a support at particular moving average, you can pretty much know that reversal is on the cards. Example - Nifty closed below 50 day moving average for the first time on Jan 17 2008 after 10th Aug 2007, and we all know what happened after that.
I personally like moving averages because they are specific and give an objective view of the market. The most followed moving averages are 50 day, 100 day and 200 day moving average. They are closely tracked by professional traders and institutional investors and so they work as everyone try to do the same thing near major moving averages.
Some of my observations on how to use moving averages are -
-
There is a saying - "Bulls live above 200 day moving average and bears live below it". It means one should buy the dips if stock is above 200 day moving average and one should sell the rally if stock is below 200 day moving.
-
A buy signal is formed when a strong bullish candle (+ve day) is formed on a major moving average (like 50 day, 100 day or 200 day moving average) and William %R indicators shows oversold condition.
-
The 50 day moving average acts as an important pivot point for short to medium term traders. It has been observed that when a stock/market trades around 50-day moving average for a period of time, then without warning stock/market has a tendency to explode either to the upside or downside.
-
When a stock bounces from a major moving average, then the next moving average becomes the target. Example, recently Reliance bounced from 200 day moving average, so one should expect 100 day moving average to be the target.
-
When a stock falls below a major moving average, then the next moving average becomes the target. So, if a stock falls below 50 day moving average, then 100 day moving average becomes the target.
-
When a stock falls below 200 day moving conclusively after being above 200 day moving average for long time, you should exit. Because generally, stocks tend to go much lower before they bottom out. Example - Infosys slipped below 200 day moving average at price of 2000 and then slipped 31% after that on closing basis.
-
When stock falls from higher levels, generally a moving average will offer support level; and similarly when stock tries to rise from very low levels, a moving averages will offer resistance level.
- When a good quality business after long period of underperformance moves above 200 day moving average and sustains there, then one should look to buy such businesses as good investment bet. Recent example - Hero Honda and ITC. See ITC chart below
-
Long term investors should look to buy good quality businesses near 200 day moving average.
-
When a stock gives exponential moves in short period of time; then one should keep 50 day moving average as stop loss. A conclusive close below 50 day moving average invites large scale selling. This applies even to investors.
Moving averages are simple to follow even if you are long term investor. You should add this indicator in your tool box to make informed decisions. You can find moving averages free of cost on Yahoo Chart.
Now remember, technical analysis is all about probabilities and not certainties; and one should not get carried away and have discipline to protect oneself. I hope this article will help you understand this concept.
No comments:
Post a Comment