Saturday, July 03, 2004
Okay, folks. Here's a new term for you. It's called a Moving Average. Now that we've gotten rid of the line chart, I'm going to reintroduce it. In Technical Analysis, there is a item called the Moving Average. See figure one.
Now the thing about the Moving average is this. It tries to predict which way the stock is going to go. The line above is a twenty day moving average. It looks at how the stock has moved in the past twenty days and then guesses what it is going to do. If the past twenty has been up days, line predicts that the stock will go up. If the past twenty days have been down days, it predicts that the stock will go down. Unfortunately, a twenty moving average is not exactly accurate and does not respond well to the changes of a stock. That's why around the beginning of April, while the stock goes up, the moving average is still going down. See figure 2.
Now of course, if you look at the five day moving average, then it is much more responsive. Notice around the beginning of April that the moving average moves up more quickly as the stock goes up. The stock still jumps above the line, but the line moves almost as quickly as the stock does. See Figure 3
Now there are three moving averages here. The moving averages are set to five, twenty, and two hundred days. There are a couple of reasons for the 200 day moving average.
First off, it shows the general direction of the stock. May people say you should only buy stock that is moving up. According to this strategy, you should not buy Southwest airlines. (at least not at the time of this writing)
Secondly, some people use this as a second indicator.
Thirdly, I am red-green colorblind and often times mix up the 5 and 20 day moving average unless I make one of them black.
Now the most common trick in moving averages is to buy and sell depending on the location of the moving averages. If you would have bought when the 5 day moved above the twenty day and sold when the situations reversed, you would have noticed a very interesting phenomena.
You would have bought near the beginning of April ($14.00), and sold near the beginning of May. (14.75?) realizing a total profit of 75 cents.
You would have bought in the middle of May ($15.00) and sold near the middle of June. (15.50) In couple of days you would have realized that this was a false signal and bought back in. (15.75)
Of course you would have lost a quarter, which I will discuss later. Had you been using stops you wouldn't.
the chart ends at a value of seventeen dollars. I can tell you however that it did come down the next day. After a week's worth of trading it's given up a dollar, but not the signal.
So what are the total gains on this chart? Seventy five cents for the first trade. Then fifty cents before the false signal and a dollar twenty five afterwards. That's 2.50 a share in six months. If you had bought Southwest at the beginning of the chart ($16.00) and sold at the end of the chart ($17.00) you would have only made a dollar.
This is the sort of thing that creates day traders. Before you try this you should always back test the stock. It doesn't always work. Especially with Microsoft, but that will be for another day. This post has gotten long enough. Good night folks.
Read more about technical analysis.
Now the thing about the Moving average is this. It tries to predict which way the stock is going to go. The line above is a twenty day moving average. It looks at how the stock has moved in the past twenty days and then guesses what it is going to do. If the past twenty has been up days, line predicts that the stock will go up. If the past twenty days have been down days, it predicts that the stock will go down. Unfortunately, a twenty moving average is not exactly accurate and does not respond well to the changes of a stock. That's why around the beginning of April, while the stock goes up, the moving average is still going down. See figure 2.
Now of course, if you look at the five day moving average, then it is much more responsive. Notice around the beginning of April that the moving average moves up more quickly as the stock goes up. The stock still jumps above the line, but the line moves almost as quickly as the stock does. See Figure 3
Now there are three moving averages here. The moving averages are set to five, twenty, and two hundred days. There are a couple of reasons for the 200 day moving average.
First off, it shows the general direction of the stock. May people say you should only buy stock that is moving up. According to this strategy, you should not buy Southwest airlines. (at least not at the time of this writing)
Secondly, some people use this as a second indicator.
Thirdly, I am red-green colorblind and often times mix up the 5 and 20 day moving average unless I make one of them black.
Now the most common trick in moving averages is to buy and sell depending on the location of the moving averages. If you would have bought when the 5 day moved above the twenty day and sold when the situations reversed, you would have noticed a very interesting phenomena.
You would have bought near the beginning of April ($14.00), and sold near the beginning of May. (14.75?) realizing a total profit of 75 cents.
You would have bought in the middle of May ($15.00) and sold near the middle of June. (15.50) In couple of days you would have realized that this was a false signal and bought back in. (15.75)
Of course you would have lost a quarter, which I will discuss later. Had you been using stops you wouldn't.
the chart ends at a value of seventeen dollars. I can tell you however that it did come down the next day. After a week's worth of trading it's given up a dollar, but not the signal.
So what are the total gains on this chart? Seventy five cents for the first trade. Then fifty cents before the false signal and a dollar twenty five afterwards. That's 2.50 a share in six months. If you had bought Southwest at the beginning of the chart ($16.00) and sold at the end of the chart ($17.00) you would have only made a dollar.
This is the sort of thing that creates day traders. Before you try this you should always back test the stock. It doesn't always work. Especially with Microsoft, but that will be for another day. This post has gotten long enough. Good night folks.
Read more about technical analysis.
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