How moving averages can help you to buy stocks.

Introduction

I am excited today to share with you a guest post from The Wolf of Harcourt Street street. As some of you know, I am from the Republic of Ireland which has a population of just under 5 million. Sometimes it is hard to believe but Investing and finance can still be subjects that are widely not talked about. This is beginning to change and it is great to meet like-minded people that have similar goals as myself. I Would highly recommend checking out his substack here. So without further ado, I will pass you over to The wolf of Harcourt street.

Firstly, this is The Wolf of Harcourt Street here and I would like to start off by saying that I was delighted to be kindly invited by EMF to write a guest post on his blog. EMF was one of the only Irish accounts that I could find in this area for a long time and he has been flying the flag with honor.

The topic of this post is moving averages which is in the area of technical analysis. I will detail what a moving average is and how it can be used to your advantage when buying stocks.

What is a Moving Average?

A moving average is a stock indicator that is used in technical analysis. The moving average smooths out price data by creating a constantly updated average price. The average is taken over a specific period for example, 5 days, 50 days, 200 days, or any period you like.

By calculating the moving average, the impacts of short-term price fluctuations over a desired period are mitigated. Due to the fact that the moving average can be tailored to any time frame, it can be utilised by both long-term investors including myself or short-term traders.

Below is an example of a 50-day (purple line) and 200-day (red line) moving average for Facebook that I performed recently. As you can see, the 50-day moving average was $268.64 while the stock was trading at $269.70.

Why use a Moving Average?

As mentioned above, using a moving average helps to reduce the amount of noise on the market price. By looking at the moving average direction we can get a sense as to what direction the price is moving. If the moving average is moving up, then this means that the price has been moving up recently and if the moving average is moving down, then the price has been moving down.

The shorter the time period used to create the average, the more sensitive it will be to price changes. The longer the time period, the less sensitive the average will be. Shorter moving averages are typically used for short-term trading, while longer-term moving averages are more suited for long-term investors.

The longer the time period for the moving average, the greater the lag. Therefore, a 200-day moving average will have a much greater degree of lag than a 5-day moving average because it contains prices for the past 200 days. The 50-day and 200-day moving average figures for stocks are widely considered to be the most important trading signals for long-term investors and are generally the only two that I use myself.

How to calculate the Moving Average?

There are a few variations of the moving average calculation however the one that I use is known as the Simple Moving Average (SMA). I use Yahoo Finance to perform all the moving average calculations that I use as follows:

1. Search for the company eg Johnson & Johnson
2. Click on the “Chart” tab
3. Locate and click on “Indicators”
4. Click on “Moving Average”
5. Populate the period eg 50
6. “Date Range” select 1Y
7. “Interval” select 1D

As you can see in the above example, the 50-day moving average was $145.92 while the share price was trading at $147.78.

Signals

Moving averages can also be used to generate signals with simple price crossovers. A bullish signal is generated when price moves above the moving average. A bearish signal is generated when price moves below the moving average.

Golden Cross

The golden cross is a bullish signal in which a short-term moving average cross above a long-term moving average. A golden cross is a bullish breakout pattern formed from a crossover involving a short-term moving average such as the 50-day moving average breaking above its long-term moving average such as the 200-day moving average. The golden cross indicates a bull market on the horizon and is supported by high trading volumes.

Below is an example of a golden cross signal that I came across on Hasbro in recent times.

Death Cross

The death cross is essentially the opposite of the golden cross and indicates the potential for a selloff. The death cross arises when a stock’s short-term moving average crosses below its long-term moving average. The same 50-day and 200-day averages can be used here.

Below is an example of a death cross on Petronet. In fact, we see a lot going on in this chart. Death cross followed by golden cross followed by death cross again!

Disadvantages

Moving averages are calculated based on historical data and therefore are not a predictive tool. The market does not always follow what the moving average is suggesting. Sometimes, the market price will follow the moving average support and resistance levels and sometimes it just won’t!

Moving averages do not work well during periods of high price volatility. For example, if the price is swinging up and down it may result in multiple trend lines and reversals.

Summary

Moving averages are a great way to gain a deeper insight into what is going on with an individual stock in terms or trading activity and volume. Put simply, it makes seeing the trend easier.

In terms of my own buying strategy, I like to add to current positions when they are trading below the 50-day average where I can. If you invest monthly like me, sometimes it is just not possible but wherever there is an opportunity, I like to take advantage of it.

At this point I have already performed my full due diligence and I have conviction in the stock I am about to buy. Moving averages are not a short cut for any of the above and have limitations.

Author Bio

If you like what you have read, you can check me out on Twitter here. I am an ordinary guy looking to achieve extraordinary investing returns. I am also the author of a blog where I release a weekly newsletter in the area of investing and personal finance with the mission of making investing knowledge accessible to all. Here is a link to the Wolf of Harcourt Street Newsletter where you will also be able to view all of my previous posts.

EMF Conclusion

While I personally prefer fundamental analysis, Technical analysis can be a great tool to supplement your decision making on when you feel is a good time to buy dividend stocks. Timing the market ca be extremely difficult but using simple tools like the RSI and Moving Averages can help you locate good entry points.

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