In My Mind's Zen Garden
No Comments 24 Views

Technical Analysis: Understanding the Concept of Moving Averages

I’ve been investing in stocks since 2007, and have only been actively trading the last couple of years. So, I confess, I still feel like a novice.

But I’ve learned one thing, and that is, when the entire market goes down you don’t panic and sell everything. Be patient, and eventually the stock market will correct itself and push onward.

Of course, in 2008, the year after I was just getting into stocks, the market totally crashed and we had what many have said was the biggest financial disaster since the Great Depression.

Still, investors are making money from the stock market, otherwise you wouldn’t have billionaire investors profiting from the stock market right now, Warren Buffett being one of them.

Anyway, one of the key investing concepts I’ve been focusing on is the moving average, which is one of many indicators that can help investors follow the stock trends.

Moving Averages

What is a Moving Average?:

The moving average is an indicator frequently used in technical analysis showing the average value of a security’s price over a set period. Moving averages are generally used to measure momentum and define areas of possible support and resistance. —Investopedia

Resistance: I look at resistance as an imaginary ceiling in which the price of an uptrending stock can not go beyond. Thus, resistance. This can be caused by any number of factors.

Support: is when a stock hits an imaginary floor in which the price of a downtrending stock can’t go any lower. Thus, support. Again, any number of factors can cause this.

Rules of Moving Averages

Moving Averages are used quite often in stock charts to determine trends. Here are a few rules:

  • 1. When a moving average crosses another, this is a good indicator that a stock has begun a trend upward or downward.
  • 2. When a smaller moving average crosses above a larger moving average, usually this signals an upward trend.
  • 2. When the smaller moving average crosses below the larger moving average, this usually signals a downward trend.
  • 3. Moving Averages usually lag behind the actual trend.
  • 4. In a scenario where a third larger moving average is below the other two, and that third moving average is trending upward, this is usually an upward trend of a longer time frame.
  • 5. When the three moving averages cross each other and all are moving upward, this definitely signals a strong upward trend.

Color Coding Three Moving Averages

Here’s the key to identifying the moving averages in the 1 year chart below. The same hierarchy applies to the next two charts below.

1 Year Chart

Here I’ve taken three different technical charts of a stock I recently purchased, American Electric Power Co. ($AEP). I’m bullish with this stock, being that it has recently hit a 52-week high and I believe it will continue its uptrend in the long term. It has an annual dividend of $1.88 a share and is really a good bargain considering it’s recent stock price of $44.85.

American Electric Power Company, Inc. (AEP) is a utility holding company that owns, directly or indirectly, all of the outstanding common stock of its public utility subsidiaries and varying percentages of other subsidiaries. The service areas of AEP’s public utility subsidiaries cover portions of the states of Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia and West Virginia.

AEP technical chart

Notes:

  • The 365 day moving average is in purple. And the fact that the other two smaller moving averages are above the 365 day moving average is a good sign.
  • Another good sign is the fact that the 365 day moving average is also uptrending.
  • Halfway through the chart (from left to right) you’ll notice the 50 day moving average crosses above the 100 day moving average, signaling an uptrend.
  • You’ll also notice the lag in that the point in which the two lines intersect is a little bit past the beginning of the actual uptrend.
  • Also note the stock price touching (and falling just below) the 365 moving day average.
  • In the first half of the chart it’s a bit choppy but you can see an uptrend as the 50 day moving average crosses above the 100 day moving average, but then falls back below.
  • Also in the second half of the chart, momentum (for the most part) is solid and in the green, reflecting the uptrend above.

3 Month Chart

AEP technical chart

Notes:

  • This chart is pretty straight forward, as the stock is totally in uptrend mode.
  • In the 3 month range, the 60 day moving average is in a good uptrend. The 10 and 20 DMAs are also trending upward and well above the 60 DMA.
  • Notice the 2 crossovers between the 10 and 20 DMAs? The second crossover shows the 10 DMA crossing over the 20 DMA and this signals a good uptrend.
  • At the bottom of the chart you can see the momentum picking up. The volume indicator shows lower volume as shareholders hold their positions for the uptrend. Not as many investors buying into the uptrend, and not as many shareholders selling their positions.

2 Week Chart

AEP technical chart

Notes:

  • The 2 week chart represents a more detailed look at the stock’s most recent performance.
  • As you can see, it gets a bit “choppy” here because the stock is hitting some resistance close to the 52-week high.
  • The purple 50 DMA indicates to me that the stock is still uptrending gradually.
  • Performance is choppy during the first half of the chart, but in the second half you can see the 10 DMA crossover the 20 DMA and trending upwards. But at the end of the chart the 10 DMA once again crosses under the 20 DMA.
  • This chart is definitely a good example of some resistance happening, and we’ll see if the stock price breaks through and continues its uptrend.


About the author:
Has 3153 Articles

Carlos Rull is a musician living in the San Diego area. His interests include Yoga, Eastern Philosophy, Zen Buddhism, and Gardening. He plays drums, piano, and composes New Age & Ambient music, and his albums are available on iTunes and Amazon.com.

LEAVE YOUR COMMENT

RELATED ARTICLES

Back to Top