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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
If you need help organizing your financial plan, reviewing your investments, or just want a second opinion to make sure you’re on the right track, please reach out to [email protected]!