The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
) -- One of the questions we get from readers is, "What is an EASY way to use technical analysis to assist in the investment process?" We use a number of indicators at
, some of which are complex, and some quite simple, to assist investors in monitoring the trend. We have been asked to describe some of these in a series of articles, and we will do this to start off the New Year. We start with
Moving averages come in various shapes and sizes. Any good technical analysis text can provide the mechanics of construction (We often recommend John Murphy's "Technical Analysis of Financial Markets"). However, often analysts make moving averages more complex than they need to be!
Moving averages smooth out a series of price data, and enable investors to discern trends more easily
. The main drawback to the moving average method is that signals can be late, resulting in what are popularly known as "whipsaws" - which occur when price moves too quickly to allow a moving average method to garner a profit. Some moving average methods have become very popular, yet in our opinion are less effective than other, more modern alternatives. The "Golden Cross", or the 50 and 200 day moving average, is an example of this, in our opinion.
At The FRED Report, we use two moving averages, the 5 and 20 period, on a daily and weekly basis, and on occasion use monthly charts as well
. We have found, over time, that these will catch all major moves in the markets, while minimizing the effects of whipsaws. The ability to use modern computer technology to expand the timeframe covered by the moving average is an advantage the inventors of the "Golden Cross" did not have - 5 days becomes 5 weeks or even 5 months, at the click of a mouse! We show some examples below.
First, look at the S&P 500 on a monthly basis back to 1996. The basic method is to own stocks when the 5 (black line) is above the 20 (green line), and to step out of the market when the 5 moves below the 20. Note how effective this simple method has been for long-term stock investors, and ask yourself: did your results over the last 10 years equal the results from this simple method? And, bear in mind there are some ways to refine this methodology - which we will discuss in future articles.
Now let's take a gander at weekly charts of commonly traded markets over the last two years. We will look at SPY, GLD, and TLT. Stocks have been choppy with several whipsaws, but gold and bonds have had strong trends, which have been captured by the moving averages.
One of the most controversial markets of the last two years is the Euro. Will it stay or will it go? Nobody can answer this question with certainty - but how did our trusty moving averages do regarding defining the trends. We show both a weekly and daily chart of FXE below, and note that buyers of the FXE sidestepped much of the downside in the Euro as well.
Moving averages are one of the building blocks of Technical Analysis.
In this article we have shown a simple moving average crossover method that cuts risk, and can capture strong trends. Readers probably can see opportunities for further refinement and research. For example, we have discussed "long only" in this article, but there may be opportunities on the short side as well. And, there are some other indicators that can be added to the mix to help investors.
and will also be the subject of future articles here at
Fred Meissner is founder and publisher of
. Fred is a CMT and past President of the Market Technicians Association (MTA). He recently left Merrill Lynch's Market Analysis Department and Sector Strategy Department to form The Fred Report. A detailed bio is here: