Invest and Trade Profitably with Jon Johnson

In attempting to determine support via the moving average or exponential moving average what time frame is used by most fund managers? One year, six months, three months etc. How should the individual investor determine which MVA to use?

August 30, 2000

What moving averages fund managers use can change over time and from stock to stock. As we like to move with the big money and anticipate its moves as well, we observe when they move into stocks and adapt accordingly. You are on the right track in wanting to know what the big money is looking at so you can look at the same thing and be ready for the moves when they occur. The shorter term moving averages range from 10 to 18 days (exponential), longer term are over 50 and 200 days (the former usually exponential though sometimes simple, the latter simple).

Moving averages are important support and resistance indicators in technical analysis, and the degree to which one is used over another often depends on what the market is showing. When a stock is moving up in a rally the 10 and 18 day moving averages often act as support and will propel a stock back up as it pulls back to that level. When the selling gets more intense, a strong stock will use its 50 day moving average as support. If a stock has been using a particular moving average as support and the stock falls through it that is a break of its pattern, and is a caution flag. When a stock breaks its 50 day moving average on strong volume, that is another caution flag as the 50 day moving average is a critical level for stocks that are trying to keep moving up. If a typically strong stock happens to break its 50 day moving average support, we will usually give it a day to recover if we are still holding it at that point.

Other important support and resistance levels include trend lines, which are similar to moving averages. They are formed by the line connecting the lows of a stock moving up (an up trendline) or the highs of a stock moving down (a down trend line). The more times a stock hits a particular trend line, the more faith we have that the line will act as support (or in the case of a down trend line, as resistance). Similar to trend lines are upper channel lines, which connect the highs of a stock moving up. If in an uptrend a stock breaks above its upper channel line on high volume, that’s a sign it is likely in for a correction soon.

Support is also formed the longer a stock stays at a particular level. Whenever a stock hits a particular level, imagine that it puts a groove in that level. Every time it touches that same level, it makes a little bit deeper groove. Picture a stock moving sideways day after day. It moves up off of that level with some pretty big moves, but then the market sells. As the stock slides back down the backside of the hill it built on the move up, it skims over the levels it never closed at. When it hits one of those ‘grooved’ areas where the stock spent a lot of time, it tends to fall into that ‘grooved’ area and that stops the slide. Old tops in such a grooved area are usually the strongest support, but the lows in the grooved range can also hold. If the selling is intense, it may push the stock right past the grooved area-the longer a stock stays at a level, the stronger the support.

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