Moving averages

moving averages Trading lessons

Oftentimes the 200 day moving average will act as support prior to a large gap down in price.

The price break below the 200 day moving average is typically done on higher than average volume.

Why do moving averages act often act as support to falling prices? Follow along while we investigate the possibilities.

In case you are wondering why I am talking about the 200 day MA, it’s simple. Everyone else looks at this moving average. When I say everyone else – I mean everyone else with a large amount of money in their pockets. Typically, mutual fund managers, money managers, and institutions need to enter and exit a stock by scaling in and out of positions.

A stock that is in “favor” will typically have a rising 200 day moving average. It’s rising because more people are interested in owning this stock then in selling it. Over time, this becomes almost a self fulfilling cycle. People want to own the stock, the stock rises, more people want to own the stock because it’s rising, the stock keeps rising, etc, etc, etc.

Of course, stocks don’t go straight up without taking a break. When rising stocks pause, they often stop right at or near their 200 day moving average. You’ll often be presented with a low risk opportunity to buy a stock near the 200 day moving average.

See the chart for Lucent Technologies back in late 1997 – early 1998.

Not shown is that LU trended up for quite some time before consolidating. Just before price started to resume the upward trend, LU made a few more attempts at going down. But right below current Prices was the almighty 200 day moving average.

After a few futile attempts, price took off like a rocket. This is what I mean by the 200 day moving average acting as support to falling prices.

Wouldn’t be nice if it was always so easy. Just wait until you find a stock that has a rising moving average, let price “touch” the MA, then buy as it starts to go back up.

Take the less than obvious path .

There’s a better way to use the 200 day moving average.

I mentioned that stocks don’t go up forever (as if you didn’t already know that). And often a stock will make a “last stand” along the 200 day moving average. And then .

Watch out below! For stocks falling, and I do mean falling, a break in price below the 200 day moving average can be the signal to unload a long term favorite or even sell short.

Here’s some examples.

Here’s Eli Lilly & Co, making a break below the 200 day moving average on higher than normal volume.

Notice that LLY tried to move back above the 200 day MA, but failed.

Juniper Networks makes a low right at the rising 200 day moving average . then breaks below. What’s interesting is the stock price rallies right back up above the moving average. This just goes to show that any method used for trading stocks is not pErfect. Remember to know your exit point when trading stocks.

FYI . JNPR continued to decline through 2001, making a low of $8.900 in September (2001 high was $145.000).

Walgreen trades along the 200 day MA for approximately a month and a half before decisively breaking lower.

A different twist on the same concept . Microsoft trading well above the 200 day moving average, then opening the next day just below the MA. The open was more than

$12 lower than the previous day’s close.

Large breaks in price below the 200 day moving average usually occur on negative news. Typically, the stock will open below the previous day’s low. Traders can take advantage of these situations by monitoring stocks that are down significantly on higher than normal volume and selling short. As long as the stock closes lower than it’s open, the chances for follow through to the downside are high.

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