Technical Analysis Part 2 Downside of Moving Averages
Posted by admin on February 25, 2009
I discussed the benefits of using moving averages in Technical Analysis Part 1. Lets talk now about the detriments of the moving averages.
The first thing is that you have to use a valuable period. If you use to short of a period on the moving average you can get “whipsawed”. Moving averages are designed to identify the trend of a stock or index, which means you will miss the beginning and not get out until the down cycle has started. If a stock or the market is not moving in a trend and is moving sideways you could have buy and sell signals telling you to sell before it turns up and buy right before it goes back down.
One of the reasons that longer term moving averages work better for the market as a whole is that the US economy is cyclical and moves in business cycles which are usually trends that can be followed. The average economic growth cycle lasts between 3-5 years before a recession reduces economic growth. The average recession I believe lasts between 12 to 24 months. Now the stock market as we all know is a discounting mechanism and goes up in anticipation of the economy moving forward and begins going down usually when the first bad news starts coming out. So moving averages are not perfect indicators, but they do allow you to recognize trends.
In my previous post Technical Analysis Part 1 Moving Average I provided an example of going long when the 50 day MA crossed above the 200 day MA and going to cash when it crossed below the 200 day MA. This is a conservative option for conservative investors that should allow you to preserve capital and get out when the market begins moving down.
I would also like to reiterate that I still believe you only buy good stable companies (apparently that didn’t work if you owned the banks) or low cost index funds and use the technical analysis of the market and the stock to help identify when is a good time to buy.
As always please read the disclaimer as I am not a licensed financial or tax advisor. There is a risk of loss in any kind of investing. Please only use risk capital. I do not have a dollar position, but am long GLD via call options and various individual stocks.
