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Investopedia Academy - Technical Analysis - Lesson 5.5 - Moving Averages - YouTube
Channel: Mike's Trading Channel
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A moving average is a smoothing mechanism聽
there are different types of moving averages聽聽
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you have a simple moving average an exponential聽
moving average a geometric moving average for聽聽
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this educational series we're going to focus on聽
the simple moving average and really what it does聽聽
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is it adds up all of the closing prices and then聽
divides that total by the amount of periods in聽聽
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discussion so for example if we're looking聽
at a 200-day simple moving average the way聽聽
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the formula works is that you are adding up the聽
closing prices from the last 200 days of trading聽聽
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and then you're dividing that number by 200 and聽
that is the period that data point in the moving聽聽
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average now the next day what you're going to聽
do is you're going to add the new data point聽聽
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the new closing price for that聽
day and you're going to subtract聽聽
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the closing price from 201 days ago and every day聽
that goes by you're going to do the same thing聽聽
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hence why it's called a moving average one of聽
the things that i would like to reiterate is聽聽
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that this moving average is not for support and聽
resistance purposes this is something that we're聽聽
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going to discuss in a later module the only聽
thing that we're using a moving average for聽聽
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is to supplement the analysis that we're doing聽
on actual price the moving average is a smoothing聽聽
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mechanism it smooths out all of those prices and聽
helps us eliminate that noise why for the sole聽聽
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purpose of helping us identify the direction of聽
the underlying trend that is the only reason why聽聽
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we're using it so follow me here we're going聽
to take a look at an example of the solar聽聽
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stocks this is the solar energy exchange traded聽
fund cleverly named with the ticker symbol tan聽聽
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and here we have an uptrend in solar聽
stocks throughout the second half of 2013聽聽
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but we have a downward sloping 200-day moving聽
average so what we not only want to look at the聽聽
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direction of price but we want to see in what聽
direction that smoothing mechanism is heading聽聽
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if prices are making lower lows and lower highs聽
below a downward sloping 200-day moving average聽聽
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it's probably not in an uptrend and i think this聽
is a great example and if you could focus in right聽聽
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here that breakout that we saw we're going to talk聽
about triangles in the pattern recognition segment聽聽
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but in this case when you had a breakout out of聽
this consolidation which as we'll discuss is a聽聽
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bullish uh it has bullish implications the fact聽
that we had a downward sloping 200-day moving聽聽
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average simultaneously was evidence that that聽
breakout was likely to fail because the direction聽聽
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of the underlying trend is still to the downside聽
the next chart that we're going to look at is the聽聽
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s p 500 going back a couple of years this is in聽
2012 you can see that prices in the s p 500 were聽聽
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in a clear uptrend going from the lower left to聽
the upper right and the 200 day moving average聽聽
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is also upward sloping while we're on the subject聽
i want to reiterate why it is that i use a 200-day聽聽
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moving average and that's for my personal time聽
horizon like i said before i like looking out聽聽
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weeks and months ahead of time i don't care what聽
happened today i don't care what happens next year聽聽
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so the 200-day moving average is basically聽
going to give me the average close from pretty聽聽
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much the last year about 10 11 months or so聽
so for my time horizon i think it's great聽聽
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a lot of people use a 50-day moving average some聽
people use a 100-day or a 150-day moving average聽聽
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and based on your time horizon that might be right聽
for you for me i like using that 200-day moving聽聽
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average Paul Tudor Jones one of the greatest聽
investors of all time also uses a 200-day moving聽聽
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average so i guess I'm in good company one thing聽
i want to reiterate in this chart is that notice聽聽
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how prices within the uptrend in the s p 500 on聽
multiple occasions fell below that moving average聽聽
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that doesn't necessarily mean that it's bearish聽
you'll often see headlines and news about how聽聽
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a given market fell below a moving average or rows聽
above a moving average without putting that into聽聽
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context that doesn't mean anything in this case聽
the fact that prices fell below the moving average聽聽
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that was bullish because the moving average is聽
heading higher those were opportunities to be聽聽
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buying weakness within an underlying聽
uptrend and these were two great examples聽聽
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the last thing that i want to point out is聽
when we have that flat 200-day moving average聽聽
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that evidence of a lack of trend and if you see聽
here we're looking at emerging markets in 2013聽聽
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and we have no trend we have a sideways聽
trend well we're not going anywhere聽聽
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and you have that flat 200-day moving average聽
right with it that's evidence that there is no聽聽
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trend and we want to avoid stocks that聽
are near flat 200-day moving averages聽聽
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there are a lot of lessons guys that I've learned聽
from my predecessors things that we're going to聽聽
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talk about here today like Dow theory and moving聽
averages and identifying trends this is classic聽聽
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stuff in this case this is one lesson that i had聽
to learn myself staying away from stocks that are聽聽
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trading near flat 200-day moving averages if you聽
want headaches these are the stocks you want to聽聽
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be buying if you want to avoid headaches stay away聽
from it completely what happens is breakouts tend聽聽
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to fail they don't hold to the upside breakdowns聽
also tend to fail they don't hold to the downside聽聽
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you get a lot of whippy action so if you聽
find yourself in one of these environments聽聽
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perhaps selling volatility or something聽
like that might be in your best interest but聽聽
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if you're in the business of identifying聽
trends if you're trying to buy things in聽聽
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up trends if you're trying to sell things in聽
downtrends when you see something like this聽聽
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priced near a flat 200 period moving average聽
from the bottom of my heart just stay away.
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