What is a moving average?
For example, assume you have 5 daily stock closing prices (Mon,Tue,Wed, Thu,Fri) that are averaged together for a weekly average. A moving average can be created the following week by dropping the previous Monday and adding the following Monday to have a new 5 day average(Tue,Wed,Thu,Fri,Mon). As day to day closing prices get higher or lower a trend line begins to develop. We prefer to use the exponential moving average as more recent prices are more heavily weighted.
What is the significance of the 50-DMA?
The beauty of using the 50-DMA is predominately its pure simplicity. It is very accurate and reliable and of the many tools we use, this one should rank high on your list. A quick look at a chart reveals how the stock is doing relative to its 50-DMA.
If the 50-DMA is rising, the stock is strong and, on the average, there is more buying going on than selling. Also, if the stock is experiencing a period of strength, the 50-DMA serves as a support level.
Conversely, if the 50-DMA is falling, the stock is weak and, on the average, there is more selling going on than buying. Also, if the stock is experiencing a period of weakness, the 50-DMA serves as resistance.
Using the 50-DMA as opposed to a shorter timeframe indicator, like a 22-DMA (the number of average trading days in a month) tends to smooth out a lot of the jiggles and bumps present in the shorter term moving averages. But the 22-DMA can be quite valuable in that super strong stocks often trade above the 22-DMA or 10-DMA.
Analyzing stocks doesn't have to be complicated. Often the better techniques are the simplest ones. One word of caution. No technique should be used as in stand alone. If the reason that a stock has declined to the 50-DMA is because of bad news, poor earnings or other negative factors, you must consider these factors in conjunction with the technical factors.
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