Unmasking The Voodoo: Moving Averages

As with all technical indicators, moving averages are just tools chartists use to figure out what they need to do in the markets. Notice I said they are figuring out their own actions, not divining where the market is going. Of course, the two are related but that is not the point.

What is the point is that pundits and journalists like to report when the market breaks one of the more widely followed moving averages. In this edition of Unmasking I am going to take a look at what a move through an average - or a "crossover" - really means.

Let's start with just what a moving average is. If you want the full definition feel free to fire up the google, the bing or even (shudder) the yahoo. And if you know what a moving average is, feel free to skip the next two paragraphs.

A moving average, or average, is just an mean price over a certain period of time. A 50-day average is the sum of all prices - usually the close prices - divided by 50.Easy peasy.Since the calculation is redone fresh each period, the value window of data "moves" over time. Get it? Moving average!

Yes, we can change the span, period, input type and even the weighting of the calculation using any number of oddball formulas but again, if you want to learn about that, it's back to the google for you. 

So what is the big deal with these things? Do they create trade triggers? Which ones do we use?

To answer the last two questions: maybe and whatever floats your boat. Yeah, not much help but these are answers you need to develop on your own. I'll just tell you what I do with them.

And to the first question, the big deal is that they help us see the forest for the trees. They smooth out jumpy price action to let you see the major and minor trends. You change the parameters depending on what you are trying to do.

You do realize that the government actually uses a moving average on some of its big monthly economic reports, right? Why? They say it smooths things out. Score one for the chartists. 

You can use averages in pairs or even triplets, garnering insights as the averages dance around each other and with the price plot. But let's KISS (keep it simple, stupid).

Let's talk about the 50-day moving average. Yesterday, August 10, 2017, the S&P 500 and Nasdaq both closed below their 50-day averages for the first time since July (June for the Nasdaq). The financial headlines were quick to point that out and with the news of the day - a potential nuke crisis in North Korea - boy did they make a big deal. Gotta build the click through count. 

Chicken Little was ready to sell everything and head for the hills. Now, can we take a peak at the headline from July 6, 2017 when the S&P 500 last closed below this red line in the sand?

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Disclosure: No positions in anything covered.

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