Moving Averages as Support

Moving Averages as Support

When witnessing a downtrend, how do we tell when a bottom is getting nearby? As described in other chapters of this book, it could be witnessing the panic selling coming into a price trend, as the stochastics are getting toward the oversold area. That is a helpful alert but does not give us a roadmap to where panic selling might end. Utilizing the 50-day moving average and the 200-day moving average as important support/resistance areas, a target can be estab­lished. Being able to evaluate the potential target makes analysis preparation easier. It prepares the investor to anticipate candlestick formations. For ex­ample, if a sustained downtrend is now showing large dark candles and is approaching one of the major moving averages, it is evidently indicating the panic bottom may be near. Panic selling with stochastics approaching the over­sold area, at or near a major moving average, has a probability of a candlestick reversal signal. This pattern alerts the trader to prepare for a candlestick “buy” signal.

Do all charts work well with moving averages? Definitely not! However, a large majority appear to. The purpose of candlestick analysis is to provide an advantage for the investor to see what is happening at important technical levels. The candlestick signals provide that clarity. If a chart is not providing clear patterns for indicating price movement, then move onto another chart. There are many from which to choose, especially with the availability of easy- to-use computer scanning programs.

Combining technical methods with candlestick signals puts the probabili­ties in favor of the investor. How do you discover whether the major moving averages are a positive correlation when anticipating price moves? Easy! Inves­tigate what has happened at those moving averages previously in the price trend. This can be done very quickly. Expand the chart. Take a quick visual analysis of what happened in the past.

Fig. 3-1, The United Defense Industries Inc. chart illustrates an example of using past trading patterns to anticipate what might happen. As seen in the chart illustration, the 50-day moving average seems to have importance during May and June.

In addition, the pullback in late July stopped right on the 50-day moving aver­age with a Meeting Line signal (a secondary candlestick signal), a couple of Doji, then a Bullish Engulfing Signal that came up off the 50-day moving aver­age. That started the next strong run up. As it consolidated through September and October, the 50-day moving average came up to meet the price. Stochastics are back in the oversold area when a very strong bullish engulfing signal forms again right on the 50-day moving average.

To further analyze whether the moving averages are important in this stock price move, the charts can be taken back further. It can be clearly seen that back in February and March, the 50-day moving average acted as resistance while the 200-day moving average acted as support. Once the price broke out of the pennant formation from that timeframe, it moved out away from the 50- day moving average before coming back and finding support on it. Bottom line, even without all the verbal description of what happened, it only takes an instant to visually analyze that the price of this stock is greatly influenced by the major moving averages.

The decision to buy, upon seeing the Bullish Engulfing pattern, is that much easier when the signal occurs at the 50-day moving average. This analy­sis is putting as many factors as possible into making a trade decision. A Bullish Engulfing Signal occurring when the stochastics are in the oversold area, start­ing to curl up, and doing so right on the 50-day moving average, make a com­pelling reason to be buying on strength.