Technical Analysis – Moving Average

Ever heard of such saying, “Do not go against the trend” when buying a stock? So, how do you know when is the uptrend so you can confidently open your position, and when is the downtrend so you can consider closing the position by selling the stock?

Moving average is one way to tell if a stock is on a downtrend or uptrend.

How To Calculate Moving Average?

For example, a 30-day moving average is calculated by summing up all the stock closing prices for the last 30 days, and do a division by 30. Looking at the chart by plotting the trend using the moving average, you can tell if the stock is in a uptrend or downtrend.

Classification of moving average can be used as below:

5 – 20 Days (Short Term Trend)
20 – 50 Days (Mid Term Trend)
100 – 200 Days (Long Term Trend)

Let’s look at example below:

 Chart courtesy of StockCharts.com

 Another example:

 Chart courtesy of StockCharts.com

In general, the shorter moving average crosses ABOVE the next longer moving average, the stronger the uptrend. When the stock price is ABOVE the longer moving average, the stronger the uptrend.

On the opposite, the shorter moving average crosses BELOW the next longer moving average, the stronger the downtrend. When the stock price is BELOW the longer moving average, the stronger the downtrend.

What Are The Disadvantages?
1. Moving average is lacking indicator since it is calculated using the past closing prices. No one can predict future stock prices. But it does help to allow investors to set a target buy or sell price.

2. Moving average has nothing to do with the fundamental value of the stock. It is very dangerous to ignore the fundamental value (such as Price/Earning ratio, PEG ratio, Price to Book ratio). It is because even the stock is in a uptrend, it might be very much overvalue. The stock might come crashing down when something unexpected happen.

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