In our introductory article, Stock Trading Terms 101, we talked about general terms that have to do with the stock market and trading stocks. Today we will look at gaining perspective and moving average as a route to successful stock trading. In Stock Trading Terms 101 we briefly mentioned bull and bear markets and noted that there are three distinct types of trends based on length.

• A secular trend lasts more than five years.
• A primary trend lasts for more than a year but less than five.
• A trend that lasts for a few weeks or months but less than a year is called a secondary trend.

At issue for someone who is trading in the trenches, so to speak, is not that he knows the definitions of these terms but that he uses these stock trading terms and underlying concepts to gain perspective.

Price versus Market Average

Often times we look at a stock chart and think that it is displaying random numbers. The price of the stock jumps up and it jumps down. There are ways to make sense of what can look like a random jumble of numbers on a stock chart. That is to use a moving average. The stock trading term in this case is the 52 week moving average. A 52 week moving average tells you where a stock is headed over time despite sometimes confusing daily fluctuations. The moving average helps traders who engage in range trading by helping define the likely limits to stock price within a given range.

Calculate a 52 week moving average:

Take a sum of the middle price for each day of trading for each trading day for the last fifty-two weeks. Then divide this number by the number of days of trading. Because this is a moving average you need to calculate this for every day by removing the earliest day and adding the previous day.

What is the use of stock trading terms such as a 52 week moving average? A stock trader superimposes the moving average for the last 52 weeks on the same chart as daily stock prices. When the current trading range lies above the average he considers the average line to be a support level below which prices are unlikely to drop. When the current trading range lies below the average he considers this average to be a resistance level above which the price of the stock is unlikely to rise. This is a technical analysis technique that can be effective even when the trader does not consult the fundamentals that are at the base of market prices. Rather this method helps the trader tap into market sentiment and exploit market inefficiencies.

Moving Average and Trends

If a market is in a long term secular upward trend, prices will likely continue to climb month by month and year by year. However, there are commonly secondary trends within a long term trend and they may tend to take the market down. By looking at moving average for the last two or three years, the last year, and the last month, a trader can get a clear idea as to whether the market is overpriced or underpriced. He then takes a contrarian approach to trading and uses the moving average to help him buy, sell short, or trade options in order to profit from a coming market correction.

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