Moving averages have a slightly different purpose when it comes to individual stocks. When tracking indexes, it is sufficient to use the 50- and 200-day, at least on a daily time frame. When trading stocks, a 20-day moving average comes into play because the 50-day is generally too far distant to keep a stop unless the time frame is extremely long term. Consequently, many strongly trending stocks will stay in a channel line and only pull back to the 20-day.
This condition will not be the case in stocks that don’t have good relative strength, but those stocks don’t make great moves anyway. The final case study demonstrates these principles in a recent bull trend in Chevron Texaco (CVX). The first chart in “Slick move” demonstrates the early part of the move before the trend is well defined. Even though there is an early shakeout, the 20-day contains most of the price action. The 50-day moving average is less important but serves as a warning sign of a bigger correction when violated. The 200-day moving average will be important, as it will highlight the end of many corrections.
The second chart is the best part of the move. The green line is the 20-day; it does an excellent job of containing the price action. It serves as a point of entry for those looking to buy the dip. This is classic action of a strongly trending stock. Again, the 200-day marks an end to a correction in the $82-$84 price range near the 38% retracement level.
It is important to note when Fibonacci retracements come into play. Because strongly trending stocks don’t have many corrections, Fibonacci retracements are less important in the near term. However, when real corrections finally materialize, the 200-day will generally line up close to an important Fibonacci level. These Fibonacci levels are slightly different for stocks and the major indexes.
The time cycle also will be a secondary factor during a strong move. The time windows will remain in the background but still create an important high that halts this leg in the 144-day window. The 20-period average works in corrections as it contains the action from the September high to the November low.
While moving averages should be used as a guide, traders can come to anticipate higher probability tendencies. We can anticipate pullbacks or spikes to complete at or near the 50-day. We can anticipate a larger degree of trend change when the 50-day crosses over the 200-day. The size of the moving average also helps traders to understand the magnitude of the trend. Recently, the Nasdaq made a low near the 200-week moving average with the S&P 500 just below it.
It is the larger weekly line that determines whether we are experiencing a run-of-the-mill intermediate-term correction or a bear market that can last a year or more. Throughout the course of this decade, the 200-week average was taken out several times only to recover within a handful of weeks. After a violation, it is normal for price action to come back and retest the line. A failure would mean former support had turned into resistance and greatly increase the probability of a long-term bear market.
Moving averages aren’t infallible; they can and will be broken in a whipsaw market. Traders must be aware of other technical conditions and understand that averages are a general gauge more than a specific measure.
Jeff Greenblatt is the director of Lucas Wave International. He is the author of “Breakthrough Strategies for Predicting Any Market,” a Marketplace book. He can be reached via www.lucaswaveinternational.com or email@example.com .