Successful stock traders need to be extremely disciplined. Every trader should prepare a set of rules and abide by it. Everytime you stick to the rules you set, better chances of success. However most traders succumb to greed/fear and end up breaking their own rules resulting in failures. One of the rules i have set for myself is to never go short once a major resistance is broken and never go long once a major support is broken. Quite simple…eh ? But hard to follow most of the times.
I believe 50-day moving average (dma) and 200-day moving average are two pivotal values. Let us look at some charts to see how valuable these moving averages turn out to be.
First chart is the IBM chart. The blue line represents the 50 dma and the red line represents the 200 dma. If you look closely, during the month of Sept-Oct 08, IBM stock tried to break the 50 dma but wasnt successful. This is because 50-dma provides a strong resistance when stock price is below it and similarly provides a strong support when stock price is above it. All the way till Dec 08, IBM was way below 50-dma. Mid-Dec it tried to break the 50-dma on the upside. It failed for the first time, but second time it did break it. Now in early Jan 09, 50-dma become a strong support and caused the stock to bounce back from it.
Second chart is the ERTS chart. See how the 50-dma has provided strong resistance to the stock. In early Dec-08 and early Jan-09 the stock tried to break on the upside of the 50-dma, but failed miserably.
Third chart is the AAPL chart. See how the 50-dma has provided strong resistance to the stock. It has a similar story to tell. Can it break the 50-dma on the upside ?
Fourth chart is the CTX chart. CTX has had an interesting ride. In early Oct-08 the stock broke on the downside. Once it dropped below the support line of 50-dma, there was no stopping. It could not recover soon. Early Nov-08 the stock tried to break the 50-dma resistance but failed. Eventually in early Dec-08 the stock broke the resistance and has since been above the 50-dma, which now has provided excellent support to the stock. However recently it looks like its going to break on the downside of 50-dma which become a resistance line.
The key rule/lesson to take away from these charts is
- To keep an eye on the moving averages.
- To avoid shorting a stock that breaks a major resistance like the 50-dma.
- To avoid going long a stock that breaks a major support like the 50-dma.
Stick to the rules and you will be on the winning side more and more….