|Trendlines and Moving Averages|
Trendlines and Moving Averages
Please note that we have used historical data. These examples are for educational purposes only.
Welcome to the premier issue of the ChartFilter.com monthly newsletter. This newsletter is designed to provide you with tools you can use every day to make profitable investment decisions.
In each issue we'll focus on the use of a different technical indicator in real-life markets. In this issue we focus on the use of Moving Averages & Trendlines.
CURRENT TRENDS - Learning from real-life markets.
This month we'll be learning how to use a couple of the simplest, yet most important and powerful tools available to the average investor... Trendlines and Moving Averages. We'll take a look at the NASDAQ Composite Index to reveal what the long-term Moving Averages are telling us about the potential frailty of the current markets. If the NASDAQ composite once again breaks down through its 200 day MA, we could be entering a bear market.
CURRENT TRENDS - Learning from the NASDAQ
The current chart of the NASDAQ Composite Index shows that the market has maintained an overall long-term uptrend. It has, however, offered a couple of strong warning signals:
What next? How do we interpret this market? If the 50-day MA bounces back up through the 200-day MA we have a further sign of strengthening. Within the last week, the market did make a break above current resistance at roughly the 4200 level and it is staying above its 200-day MA (which is currently acting as support). The market IS in choppy waters right now, however, there's no doubt about that.
In terms of basic trend analysis, the NASDAQ will be showing increasing signs of strength if; a) there's a strong break above the 4,300 level, and b) the 200-day moving average continues to provide support. However, if the Index once again breaks down through the 200-day MA we have a further deterioration of the long-term picture for the NASDAQ and a definite sign of weakening markets.
Why did I choose the 50-day and 200-day MAs? Because I'm interested in the long-term trend in this analysis and the 50 day gives a good idea of the mid-term trend while the 200-day is a good indicator for the long term picture. Shorter term MAs, such as 5, 10, 20 and 50-day MAs, are more responsive to the market and can be very useful for the more day-to-day trading decisions. In looking at any particular stock, however, I would strongly urge you to consider the 50- and 200-day MAs to answer the question, "Where's the mid to long-term support for this market?"
Now that you've seen how these MAs can be used, why not take a look at some of the other indices - DJIA, S&P300, TSE500 -- to see what they're telling you about long-term strength or weakness in the markets.
TIPS & TECHNIQUES - Using Trendlines
An important concept in the use of trendlines is that of support and resistance. A continued trend is based on underlying support for prices in the market, for whatever reason. Similarly, there's resistance to higher prices built into the market.
The trendline is one way to capture and illustrate these zones of support and resistance. As long as the market stays within these zones of support and resistance, as shown by a trendline, the trend is sustained. Any penetration through a trendline warns of a possible change in trend. We may not know the reason behind such a change, but we do know that for some reason the support or resistance for a market is changing.
PROFIT POTENTIAL - Bombardier Inc
Bombardier has been in a strong uptrend for several months and has offered perfect opportunities for making a profit based on the signals offered by Moving Averages and Trendlines. Using a fairly straightforward system of buying when the 20-day MA crossed the 50-day MA and selling when the mid-term trendline was broken you could have made 56% return on this one stock alone in the past ten months.
Profit Potential - Bombardier Inc.
How much profit can you make using the tools we've investigated in this report; moving averages and trendlines? Let's take a look at a real-life example: Bombardier Incorporated on the Toronto Stock Exchange. Keep in mind, of course, that this chart was selected because it provides a good example during a strong up trend. On the other hand, this is exactly the type of market you want to trade in real life!
Here I'm using 20-day and 50-day Moving Averages, since I'm interested in profiting from mid- to long-term moves. This makes the trading signals more responsive to the market than the 50-day and 200-day MAs used in looking at the big picture with the NASDAQ composite index.
I've used the following straightforward entry and exit signals (marked as green and red arrows on the chart):
In real life we would also consider other, complimentary technical indicators such as DMI/ADX, Williams %R, MoneyFlow, etc. For the purposes of this example, however, you can see that the combination of Moving Averages and trendlines can provide us with very useful -- and potentially profitable - trading signals.
The profit on this hypothetical series of trades, based on purchasing 100 shares each time, would have been roughly as follows (excluding commissions):
The total for the two trades would have been about $7.50 profit or 56% return on investment, over a period of about nine months.
What about the last green arrow? In the first week of July 2000 the 20-day MA once again crossed up through the 50-day MA - a bullish signal. Keep an eye on the trendline and the MA!
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