We've discussed using the 50-day moving average to study market indexes. That same 50-day moving average can help you pick a stock winner and keep it winning for you.
To refresh your memories, the 50-day moving average is calculated by taking the closing prices from the last 50 trading days, adding them together, then dividing by 50. Plotting this alongside a stock's daily movement helps to smooth out the action and give you a better idea where a stock is in a current run.
Let's take a step back, switch your chart from daily to weekly and you can smooth the action even further. Your 50-day moving average has been replaced by the 10-week moving average. It covers the same amount of time but is calculated using 10 data points instead of 50.
The 10-week average can be your secret weapon for adding to a position, diminishing it, or cutting it altogether. A leading stock should trade above its 10-week line and bounce off the line when it pulls back. A big break below the 10-week line could be a sell signal.
After a stock breaks out of a base and makes some gains, the first and second pullbacks to the 50-day or 10-week lines can provide a way to add shares. With subsequent pullbacks, there's a higher risk that the stock won't bounce back.
Be sure that the line is above the base. If you add shares at a price below the base's buy point, you could be adding to a losing cause. The moving average should be trending up, too.
First American Financial broke out of a short six-week flat base in the middle of October 2021 with a 71.88 buy point (1).
50-Day Moving Average Offered Buy, Sell Signals
First American found 9% in gains before slowing down in late November. A five-week flat base began to form along the 10-week moving average, almost a perfect mirror of the action from October.
A sensible addition presented itself in the last week of the base, the week ended Dec. 24, 2021 (2). On Dec. 21, First American retook the 10-week moving average and stayed above it the rest of the week. That was a good show of support and provided a chance to buy or add shares.
Sure enough, First American had another 9% of profit to gain between Dec. 21 and Jan 13, 2022. It was a modest but not insignificant gain. Then, selling soon followed.
On Jan. 20, the stock broke below the 10-week moving average in heavy volume (3). In fact, there were several days of heavy selling. In this case, the 10-week line acted as a sell signal. First American tried to rebound but found resistance at the 10-week average (4), where it once found support. Later falling below the 40-week, shares sold off on earnings Feb. 10, 2022.
This article was originally published Feb. 18, 2022, and has been updated.
