How to Use Moving Averages to Time Your Investments
A fund price moving average is really quite simple. It just represents the average, or mean, of a fund’s closing share prices over a trailing time frame.
Broadly speaking, it’s healthy when a fund or stock’s share price is above its current 50- and/or 200-day moving averages. Once a fund is below those levels, you can bet that many of its component stocks are under their averages as well. This makes them vulnerable to “weak hands,” unhappy shareholders who are inclined to sell their shares, further depressing the price of the stock.
It’s also can be a bearish sign if fund pierces below its 200-day moving average after having tracked above the line. It can be bullish if an uptrending fund “support” at its 200-day, bouncing off the moving average to resume its advance.
Beware of drawing simplistic conclusions from moving averages. For instance, some people have a blind faith in a principle called reversion to the mean. This represents the idea that price movements oscillate around a moving average. So when a stock or fund share drops far below its moving average, some people it’s overdue for a bounce.
But strong share-price trends carry their moving averages with them. Tomorrow’s moving average can wind up being a lot lower than today’s!
The TradingMarkets.com FundScanner allows sort for prospective investments using up to five moving average parameters. You can can zero in on funds above or below their average share price for the past 20, 50 and 200 days and 20 and 50 weeks, and you can do so in any combination.
Some investors like to buy strong, uptrending funds or stocks on pullbacks, provided they find support at their 50- or 200-day moving averages. Such investors could use the FundScanner to draw up a list of these potential candidates. Then call up the individual charts on the listed funds for further analysis.
Some active-investing systems use moving averages as a trailing stop. Jay Kaeppel, director of research at Wheaton, Ill.-based Essex Trading Co., has developed a weekly system for trading Fidelity Select funds which involves investing in high-RS funds in uptrends, then exiting them if they violate their long-term moving averages.