Direction Of Moving Averages – Technical Analysis

In a blog post on Tuesday, I mentioned We objectively noted that the direction of a key moving average is more important than one or two closes above or below it.

This statement was made in reference to the bearishness expressed by many when, just 2 1/2 weeks earlier, the $SPY closed below the advancing 200 day moving average and the market then rocketed 7% higher. It was also noted that it was not time to become bullish that day just because the market had closed above the declining 50 day moving average.

To further add to the uncertainty on Tuesday, I wrote that it wasn’t appropriate to become bearish because the S&P 500 had retraced almost precisely 61.8% of the April high to the May low. Instead, it was time to assess risk and wait for further clues from the market for when it was appropriate to position bullish or bearish with all of the mixed messages the market was sending.

click chart to enlargen

The market is tricky, and it seems so even more lately. Technical analysis is often misinterpreted as an exact science, it is merely a tool which allows us to determine potential price based scenarios before we commit our money to a position.

Lately we have seen a lot of technical analysis misused. From a couple of closes below the 200 day moving average being interpreted as bearish, to a couple closes above the 50 day moving average being interpreted as bullish, or believing that one can buy the break above the “neckline” if the inverted head and shoulder pattern and then kick back and wait for the price objective to be met. These examples of ‘failed technical analysis’ are “proof” by doubters that technical analysis is useless. If you are going to succeed in the markets, risk management should be your first priority, regardless of what your timeframe is. I consider technical analysis to be the finest risk management tool that anyone can use if they really understand the psychology of the formation of patterns rather than focusing on pattern recognition alone.

Also from Tuesday’s post — As I often point out, moving averages should not be used as a stand alone tool, but they give us a great reference point to compare price to. We want to objectively observe how price acts around those levels on shorter term timeframes The same goes for trendlines, price patterns, oscillators, Fibonacci, etc We want to be aware of these key levels which motivate others to take action so we can ANTICIPATE the likely scenarios, but wait for price confirmation before we PARTICIPATE and put our money at risk.

Price is objective, we often we are not.