We’ve written about moving averages hundreds of times here at TradeStation as well as for Barron’s, and for most of the years we’ve been running an “Ask and Answer” site called Tradestates, we’ve heard this question asked by thousands or more “new members” who just want to get a head start on trading and to be aware of what the market is doing and not doing at any given moment. The common sentiment among new traders is to “follow the trend” – but is this right? A chart like the one shown below is a clear case of looking at a market up until its “top move.” The chart is a moving average for the S&P/TSX composite index, which is the market traded at that moment. This chart illustrates the fact that there are multiple “top moves” in the stock market at any given time.
The chart above also helps to illustrate how moving averages work. By looking at the market as a whole you don’t know which move is going to be “good” for a stock or when it will occur. So, instead, traders use a tool called moving averages to keep track of what’s going on with stocks at any particular moment in time.
Moving averages are just one kind of charting tool. The other kind of charting tool is known as momentum.
Movement of an Individual Stock Or a Mutual Fund
As we discussed a few weeks ago, a stock or mutual fund that is out of favor can be seen moving higher and lower in a moving average, which is a statistical trend. When the momentum gauge goes up, traders can make money by buying the stock when it is up and selling it when it is down. Momentum is one of the tools available to help investors identify trends when they are not sure which direction to take. The chart shown below is a momentum chart for Gannett, an American newspaper group. If you watch it closely you will notice that when the momentum gauge begins to move up it is higher than it has been before. In fact, the chart indicates a new all-time high has been reached. It is important to recognize that momentum is not just a matter of being in a good (or bad) stock; it is also a matter of knowing which stocks are on edge. You can also use momentum to help you identify which direction to sell a stock in.
What about the momentum chart that shows just how volatile an index is? The chart showing the S&P/TSX composite is
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