MOVING AVERAGES MEASURE DIFFERENT TRENDS -- WHY I PREFER A 50-DAY MOVING AVERAGE
MOVING AVERAGE TRENDS ... I use moving averages quite a bit in my chart analysis. That's because they're a simple way of telling which way market trends are moving. The three that I watch are the 20-day, the 50-day, and the 200-day. Each one measures a different trend. All three are applied to the chart of the Nasdaq Composite Index in Chart 1. The 20-day average (green line) is the most sensitive of the three and measures the "short-term" trend. In a downturn, the 20-day line is always broken first. Short-term traders use the 20-day line to exit long positions (or initiate short positions). The 50-day average (blue line) measures the "intermediate-term" trend. A close beneath that line signals a more serious correction. That's when institutional traders start exiting long positions. A break of the 50-day line usually signals a further decline toward the 200-day average (red line). The 200-day line measures the "long-term" trend of a market. If a market is just in an intermediate downside correction, it should find support around the 200-day average. If it breaks the 200-day line (and stays below it), that signals the possible start of a near bear market. Chart 1 shows the Nasdaq breaking its 20-day average two days into the new year. It broke its 50-day line (and stayed beneath it) a couple of days later. It's now headed toward its 200-day line.
Chart 1
WHY I PREFER THE 50-DAY AVERAGE ... The 20-day average is usually too short for my purposes which is to spot bigger trend changes (although it is the period used in Bollinger Bands). At the same time, the 200-day average is too long. Imagine holding a long position in the market waiting to see if it breaks the 200-day average. Chart 1 shows that the Nasdaq would have to drop more than 200 points (10%) to give a sell signal. That's too much to give up in my opinion. That's why I rely most heavily on the 50-day average. One of the simple rules that I follow is to require that any sector, industry group, or stock that I'm recommending close over its 50-day average. At the same time, I consider selling anything that closes under its 50-day line. There are some conditions that I look for to confirm a downside break. The market has to "close" beneath the 50-day line and in decisive fashion. Then it has to "stay" under it. Very often a market will attempt to climb back over its 50-day line. If it fails that attempt, that's another bearish sign. I also watch the "Friday" close. That's because a Friday close determines where a market ends on a weekly bar chart. [On a weekly chart, the 50-day average is converted to a 10-week average]. A Friday close beneath a moving average is more serious than a mid-week violation. That's even more true of the 200-day (or 40-week) moving average. In Chart 1, the Nasdaq closed under its 50-day line on Wednesday, January 5 and remained beneath it through the end of the week. It never did close back above it. That's negative action -- and a pretty good reason to have considered doing some selling of longs (or initiating new shorts).
Chart 2
THE SOX AND EBAY GAVE 50-DAY SELL SIGNALS... In my view, selling something after it closes under its 50-day average is one of the best disciplines that any trader or investor can learn. This is true for market groups and individual stocks. Chart 2 shows the Semiconductor (SOX) Index breaking its 50-day average on the first day of trading in the new year (see blue circle). I recommended selling at the time based on that signal. Ebay was the worst performing stock of the past week as shown in Chart 3. It plunged 19% on Thursday. The chart shows, however, that it broke its 50-day line on Thursday, January 6 -- a full two weeks before this Thursday's price plunge. Those are just two examples of why I pay so much attention to 50-day averages. Any why you should too.
Chart 3
HISTORY OF THE 50-DAY AVERAGE... Almost two years ago I published some statistics on the 50-day average applied to the Nasdaq market February 10, 2003. Here they are again. In the 30 years from 1972 to 2002, a buy and hold strategy reaped a gain of 1,105% in the Nasdaq market. A simple timing strategy of selling whenever the Nasdaq fell under its 50-day average (and re-entering when it rose back above it) reaped a profit of 13, 794%. In the ten years from 1993 to 2002, a buy and hold strategy yielded a Nasdaq profit of 93%. By utilizing a "sell discipline" of the 50-day average, that Nasdaq profit jumped to 280%. That why I show it to you on all of my charts and write about it so much. I'm not suggesting that the 50-day line is the only technical indicator to rely on. Nor are it's signals always correct. But, in my opinion, it's one of the simplest ways to inject discipline into your trading decisions. As of today, the Nasdaq (and all the other major indexes) are trading well below their 50-day lines. That's one of the reasons I recommended taking some profits earlier in the month.
