FINANCIAL TOOL
Moving Averages
There are two types of market analysis: fundamental and technical.
Fundamental analysis focuses on actual value provided by a company. Technical analysis focuses on patterns of investor psychology that show up in the charts.
Fundamental analysis, though more difficult, has a much better track record than technical analysis in terms of long-term success.
But here’s one technical pattern which may hold some legitimacy.
Moving averages.
A moving average measures the average price point over a certain number of days.
So over 100 days, maybe the average price of an asset was $200. Maybe tomorrow, the average has ticked up to $201. The 100 days are measured on a rolling basis.
Then we can chart the change in this 100-day average on a line chart. And we can determine if the current price is above or below this average.
Two commonly watched moving averages are the 50-day and the 200-day averages.
A 2022 study by the CFA Institute’s Research & Policy Center showed that, over the last six decades, there is actually a correlation between market prices being above the 50- or 200-day moving average and the likelihood that they will increase on that day.
For example, if the moving average is $200, but the price opens at $202, they found a higher chance that the price would continue to increase rather than decrease on that day. If it opened below the average, such as $198, then there was a higher chance the price would decrease rather than increase.
Does that mean it’s better to go to cash every time a moving average is crossed to the downside?
No.
But it does potentially provide a valuable signal which, in combination with fundamental analysis, could help us determine whether a bear market may be on the horizon. And that can allow us to prepare our risk accordingly.
You can view moving averages for free at Yahoo Finance. For the asset you wish you measure, on the Summary page, click “Advanced Chart.” You can then click “Indicators” and choose “Moving Average,” which you will be able to edit for number of days.