A trio of av­er­ages to help you de­cide

How this trio can help you

Finweek English Edition - - Front Page -

CHARLES DOW, known as the orig­i­na­tor of tech­ni­cal anal­y­sis, de­vel­oped a the­ory around 100 years ago that’s still of value to­day. It in­cludes a con­cept that a mar­ket cy­cle can be com­pared to the pat­tern of the ocean’s waves. The small waves break­ing at your feet rep­re­sent the daily fluc­tu­a­tions on the mar­ket. You can’t see what the big pic­ture is. Then you have the medium-sized waves, which give you some idea of whether the tide is com­ing in or go­ing out. But it’s the big waves that show the di­rec­tion of the tide best of all.

In other words, in mov­ing av­er­ages the small waves can be com­pared to the daily price fluc­tu­a­tions and the short­term av­er­age (say four or five weeks); then comes the medium term (say 13 weeks); and fi­nally the big one of (say) 40 weeks, which gives you a good in­di­ca­tion of the mar­ket’s ba­sic trend.

It was shown last week that it’s a very im­por­tant sig­nal when the 40-week av­er­age – af­ter a bull mar­ket last­ing quite a time – rolls over down­ward, be­cause that can only hap­pen when sell­ers (bears) are dom­i­nant over the buy­ers (bulls). That’s a dan­ger sig­nal, and that’s when the man in the street is ac­tive in the mar­ket. He’s very con­fi­dent – be­cause “ev­ery­one” is mak­ing money. Ex­pe­ri­enced mar­ket play­ers know when that hap­pens the dan­ger sig­nals are flash­ing and they un­load over­val­ued shares.

The prob­lem with the 40-week av­er­age is that its sig­nals tend to ar­rive late. At the be­gin­ning of a bull mar­ket it could be so late a sub­stan­tial por­tion of the cream may be gone. In the same way, a good deal of your profit can be lost when it turns around down­ward.

To avoid that, in­vestors must look se­ri­ously at the re­la­tion­ship be­tween the trio. Be­cause, just like Dow’s waves, they flow into one an­other. The five-week av­er­age is the most sen­si­tive (and un­re­li­able) and will al­ways give the first in­di­ca­tion by turn­ing around down­ward and fall­ing to be­low the 13-week av­er­age. If it sub­se­quently also falls through the 40 weeks then you can be sure there’s real sell­ing pres­sure. How­ever, it’s when the 13 weeks falls through the 40 weeks that you should be­come concerned. The bears are busy with a real at­tack.

There are ex­pert in­vestors who look only at the three av­er­ages. The share price is elim­i­nated, be­cause they be­lieve it merely con­fuses them. The rea­son is that a price of es­pe­cially a qual­ity share sel­dom plum­mets or soars overnight. It’s usu­ally a process giv­ing you enough time to act.

Here I must em­pha­sise some­thing im­por­tant: don’t rely only on tech­ni­cal anal­y­sis. Af­ter the mar­ket has ex­pe­ri­enced a ma­jor down­turn, as in 2008, look only at qual­ity shares – and any bro­ker who knows what he’s do­ing will be able to ad­vise you on that: those that have the po­ten­tial to re­cover strongly. Be­cause grow­ing prof­its draw prices up­ward like a mag­net. So when that up­ward turn­around oc­curs it’s merely a case of in­formed buy­ers see­ing value in the share. Prices of qual­ity shares are de­ter­mined by the ma­jor in­vestors – and they usu­ally buy on the ba­sis of good re­search.

When do you know they’re buy­ing steadily?

An im­por­tant early sig­nal is when the five-week av­er­age crosses the 13-week and then the 40-week av­er­age. And when the 13-week av­er­age turns around up­ward it’s a sig­nal we may per­haps be look­ing at a new trend. And when the 13-week av­er­age pushes through the 40-week av­er­age we can as­sume we have a new bull mar­ket. As long as it re­mains above the 40 weeks you should stay with that share.

The op­po­site is the case at the top of the mar­ket: when prices are high and value scarce. It’s not dif­fi­cult to know when that’s the case. It’s a good idea to keep an eye on the me­dia. You will re­ceive am­ple warn­ing, when the 13-week av­er­age falls through the 40-week av­er­age and the lat­ter turns over down­ward, that the bear can cause you se­ri­ous harm.

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