How I Use Moving Averages

Mid-Term Trends • Long-Term Trends • High Tide • Low Tide

Simple Moving Averages

A simple moving average is a way to smooth out fluctuations in data, like stock prices. It adds up the values over a specific period, like 50 days, then divides by that period. It helps show trends and reduces noise in the data for easier analysis.

Imagine you are a surfer, when is the best time to go surfing? 

High tide, when the waves are firing! That is how I like to think of the moving averages. If the stock market is an ocean of money, the moving averages help identify the investing conditions.

The 200-Day Moving Average (MA) is the number one most important indicator I use. It helps identify the long-term trend - up or down. I think of the 200-MA as the tides in the ocean. Above the 200-MA is high tide, and below it is low tide.

The 50-Day Moving Average (MA) is my second most important indicator. It helps identify the shorter-term trend. I like to think of the 50-MA as the waves in the ocean. Above the 50-MA the waves are popping, below it, it can be a choppy mess.

We Can Use History As a Guide

Another reason why I like using moving averages is because we can use past data to provide us with objective, factual, and often very useful information. Here’s an example: Look at the information we get by answering this simple question - In the past, how did the S&P 500 Index perform three months after it extended more than 12% from its 200-day moving average?

Here are the results from the last 20 years:

This happened only 13 other times.

13 out of 13, there was a short-term decline.

On average the decline was -5.36% around 27 days after the S&P 500 extended 12% beyond its 200-day MA.

And after three months (63 trading days), the average gain was 0.75%.

Now does this mean it is going to happen again exactly like this? No, but it provides us with real data on how investors behaved when the S&P 500 hit these levels in the past, which we can then use to prepare for potential outcomes and manage expectations.

Thank you!

Brian Bond, CMT

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