Many times you may have heard some investment GURU exclaim that, “It is wise to Make the Trend your Friend.” What are they referring too. Well it could be any number of stock technicals … but today we will focus on only one … the Moving Average of the Stock Price over various periods of time.
I personally like to use a Simple Moving Average over periods of 10, 20, 50 and 200 days. What does this mean? Using the 10 day to keep it short it would be something like this:
|Day||Price||10 Day Moving Average|
To calculate the Moving average after the 9th day (or period) I simple average the last ten dates. The next average dropped the 1st period and added the 11th. The next dropped the 2nd period and added the 12th and so on – so that the most was a 10 day average of price.
If we looked at this graphically, it would look similar to this:
Notice how the ten day simple moving average smooths out the daily price trend. Now let’s look at a real example.
Here is a chart of Apple Stock showing the price action only:
Now if you were looking to buy this stock with the price trending down since early September … you may have second thoughts. However, let’s take off price and include the 10, 20, 50 and 200 day Simple Moving Average’s only.
The blue line represents the 10 day Simple Moving Average. The purple line is the 20 day Simple Moving Average. The Yellow line is the 50 day Simple Moving Average. The red line represents the 200 day Simple Moving Average. While it is true that the blue line (10 day average) has pulled back some to even meet the 20 day moving average (purple line) … we see that the 50 day and the 200 day moving average is still plowing upward and onward. Of course the 10 and 20 day averages will be more volatile than the 50 or 200 day average because of fewer prices averaged.
The Apple Graph above would suggest that while the short-term trend of Apple Stock may be in a decline … the longer term trends are moving upward. I personally would not have a problem buying Apple Stock or longer term call options knowing these trends.
Notice in Figure 3 all you see is price and it appears that it is moving down. This is why when I look at a chart I like to include at least 2 to 4 averages over various periods to see how the stock is trending long-term and short-term. I will base my investment decisions on what I see. Let me add also that in many cases … using the system of graphs that I use … I will many times remove the price all together to reach a decision based on short-term and long-term trend alone. Many times I find that Price (and other things you can place on a graph) are just added noise that can cloud a person’s judgement.
Following is a series of charts were I have removed the price and only included the 10, 20, 50 and 200 day moving averages of price for the past 6 months. Let’s see which of these companies you should consider investing into for the short or long-term. I’ve pulled these companies from the Dow Jones Industrial Average Index since it represent 30 of the largest well known companies in America over various investment sectors.
I will not review all 30 companies in the index. Counting Apple Computer (which was looked at earlier) we will look at a total of 20 companies out of 30.
Remember as you look at these charts the blue line is the 10 day moving average, the purple line is the 20 day moving average, the yellow line is the 50 day moving average and the red line is the 200 day moving average. These charts are not in any particular order and I will not be repeating the AAPL chart already shown in Figure 4 above.
In TRV we see that three averages are below the major 200 day moving average and the 200 day moving average is trending down. Here I probably would not buy the stock or a CALL option. However, it may be a good idea to consider selling TRV short or potentially buying a PUT option since it looks like the trend could continue to decline at least short term. If the 10, 20 and 50 day moving average crosses the 200 day moving average to the upside and starts to make the 200 day moving average trend up … then you may want to consider buying the stock or a CALL option.
Now this is an interesting one. Since Mid July the shorter term 10, 20 and 50 moving averages have been trending up. In August the 10 and 20 day crossed the 200 day average and it appears today that the 50 day average came close to crossing the 200 day moving average. This could be a good time to put a little money on the table for MRK either by purchasing the stock or a longer-term Call option. However, only invest a reasonable amount.
Now this is a stock that I just love. It appears the 50 day moving average has been above the 200 day moving average for the entire 6 month period we are looking at. However the 10 and 20 day moving average shows how volatile this stock price movements have been for the past 6 months. That longer term red line is increasing nicely and for stock investors … remember JNJ pays a nice dividend and has increased its dividend every year for at least the last 30 years if not longer, though all economic upturns and downturns.
Another interesting one to consider. The 10, 20 and 50 day moving average crossed above the 200 day moving average in late July and early August. As of now it has flattened out the 200 day moving average and if the shorter term averages continue to trend up should force the 200 day average higher. I see this as a good long-term hold and one to consider purchasing now.
Whoa now … unless you are a died in the wool contrarian … you may want to stay away from this one for awhile. Not saying it can’t turn around later and be a good purchase … but with the shorter term averages pulling that 200 day moving average back down … I’d say if you want Semiconductor Manufacturing stock there is probably much better positions out there. Again this opinion is based on technical moving averages alone and has nothing to do with other technical indicators or fundamentals of the company.
Now this is another good looking one right now. All major averages are trending up … though there is volatility in the shorter-term this would probably be a good one to consider just based off this chart … not to mention that now medication is being worked on by many Drug Companies (included JNJ) for Covid-19.
There is not a lot of attraction here at the present time. Had you purchased this stock back in April of this year you have likely made some money; however, with the averages flattening out I’d say the stock is not in a period of “consolidation” and after that ends there is a 50/50 chance that trend could be up or down. Put this one on your watch list … but be skeptical about getting into it right now – based solely on the chart information of averages.
This is another stock with all four of the averages starting to trend up quite nicely. I would not have heartburn jumping into this stock now with the purchase of shares or CALL Options.
“I’m Lovin’ It” — the three shorter term trends are starting to drag that longer-term 200 day trend upward. This would be a good stock to consider purchasing. CALL options should do well also.
Wow, look at Home Depot. Since the Pandemic (or Plandemic) this retail DIY store has been going up in price. To purchase stock or CALL Options on this one would be a pretty solid bet today.
All three of the shorter-term averages have crossed that 200 day moving average to the upside and may be an ideal time to get into this one if you think that trend is going to continue. I’d certainly not sell them Short or purchase PUT options on them.
Though I like AXP (they’ve paid me a lot of money over the years from 1984 – 2005 when they owned the company I worked for) I would hold off investing until I see that 50 day Simple Moving Average cross the 200 day Moving Average to the upside.
This Insurance Company has been in a nice uptrend since early April. However, it appears that the shorter term averages and not moving up that much lately and could break below the 50 day moving average. If that happens for any significant period of time … it is going to force that 200 day Moving Average to go lower.
Here’s a great stock since early April. I will not say a great store. I don’t like shopping there … but their stock … based on these moving averages have been in a nice uptrend and I would have no problem buying it now.
For political reasons I don’t really agree with some of the things that founder Bill Gates has done lately … but thankfully he is not at the helm running Microsoft on a day to day basis. This stock has a long-term trend of price appreciation (look at the 200 day MA and the 50 MA). Yes, shorter term it’s a little volatile but you can buying feeling reasonably sure that if held long enough … you will be rewarded.
Another company I don’t always agree with politically … but they do have a nice strong growth trend going on right now.
I, like others, hate paying the bill every month it comes … but the trend of the stock has been up so I guess I will continue to pay the bill.
What a disappointment this one has been to me. I used to have a lot of money in this one (the key words … “Used To”). I still hold a few CALL Options on this one … but by the looks of this chart it is time to close out what I have there and use the proceeds to buy a few PUT options in an attempt to get some of my money back.
Wow a nice trend up … and look at the pop on this one since about the end of August. This is probably when it was announced that they would be included in the Dow Jones Industrial Average Index. If your interested in some nice technology stocks … this may be one to consider after doing more research on it.
As you saw in these charts … most of these up trends actually started in early April. The months of February and March of 2020 saw a decline on most (not all) stock in the market due to Coronavirus and the American Economy basically coming to a screeching halt.
The bottom of the market for what I call the Covid-19 2020 crash was on March 23rd. However, no one could tell you that for sure on March 23rd. I’d say by April 1, 2020 … many people who had left the market had started to get back in.
Fig. 24 below shows what would have happened had you invested an equal amount of money in all 30 stocks of the Dow Jones Industrial Average at the open on April 1, 2020 and sold them at the close on September 14, 2020. A holding period of about 5-1/2 months (and I don’t necessarily recommend short-term trading such as this).
Let’s see how a person could have made out had they purchased based on moving average vs. simply buying all the stocks in an index.
Notice that 28 of the 30 stocks would have made you a profit from 5.32% to 91.53% … whereas 2 would have lost between 4.76% and 18.41%. Overall, not too bad … an average Return on Investment (ROI) of 31.01%. Annualized that would equate to a return of 68.24% if the trends continue.
However, looking at the bottom of the graph we see the Dow Jones Industrial Average itself returned 33.66% for an annualized ROI of 74.06%. How did this occur?
The DJIA index is actually a weighted index where the biggest stocks in regard to market capitalization gets a higher weighing than some of the smaller stocks. Market capitalization is simply the price per share of stock times the outstanding shares of stock. So, if the price per share is say $50 and the number of shares out on the market is 10,000,000 … the market capitalization would be $50 x $10,000,000 or $500,000,000. Needless to say that all the stocks in the DJIA are valued at much greater amounts.
The largest company in the DJIA is Apple (AAPL) with a market capitalization of $200.250 Billion as of this writing and the smallest company in the DJIA is Travelers Insurance (TRV) with a market capitalization of $28.706 Billion. Thus AAPL get’s a much higher weighting in the average than does TRV.
So, in this case … if you were looking to really increase gains using stocks of the Dow Jones Industrial Average … you would have been better off purchasing a Dow Jones Index Exchange Traded Fund (ETF) that is designed to actually track the index.
As shown in Fig. 25 below … the SPDR Dow Jones Index Fund (DIA) actually would have done much better for you over the same period of time.
BUT, how would you have faired if you used an approach to base your investment decisions on Moving Averages and “Making the Trend Your Friend?”
Fig. 26 below shows what would have happened had you purchased only those stocks in the Dow Jones Industrial Average Index that shows all four of the average prices (10, 20, 50 and 200 day) moving upwards. You will note that only 8 stocks met this criteria. I refer to this as “Cherry Picking” your stocks.
Here we see that over the same period of time your stocks would have returned an average of 44.75% which annualizes to a rate of 98.44%.
The graphs and backtesting software used in this article comes from Vectorvest which can be purchased and downloaded at www.vectorvest.com.
ONE IMPORTANT NOTE: When we say, for example, 30 day moving average — we only mean daily moving average if we are referring to a daily chart. If we are referring to a weekly chart then the 30 MA would be 30 weeks. If we are referring to a minute chart (intraday) than a 30 MA would be 30 minutes. The 30 is the period which could be minutes, 5-minute periods, days, weeks or months … depending on the type of chart one is using.
WHAT YOU SHOULD HAVE LEARNED: There is more to consider than simply price action when it comes to purchasing stocks or options on stocks. Following the moving averages – even if it the 30 and 60 day (period) averages – makes more sense if you truly want to Make the Trend Your Friend.
People always ask me, “Why would you want to purchase a stock that seems to be at a high?”
I normally respond with, “Why would you buy one that is low and seems to be trending lower?”
You are never going to get in at an all time low and out at an all time high. It’s next to impossible. But you will make money more times than not by Making The Trend Your Friend and using the price action averages.
Warning: This should not be considered as investment advice. I am not recommending that anyone reading this go out and purchase stocks or options on any of the stocks covered. I did this report simply to show an alternative approach to picking stock other than looking at the price alone. All test ran were simply backtest and not a prediction of future performance. No one has a “crystal ball” that is going to tell you that any stock picking or option picking idea is a guarantee of profits in the future. This is for educational purposes only.
Disclaimer: As the writer of this article I hold positions (stock or options) in the following that were mentioned in the article: AAPL, JNJ, CAT, PG, MCD, MSFT, BA and CRM.