APPLICATION OF THE TOOL OF MOVING AVERAGE

In a previous post I had explained the concept of moving average as a technical tool to understand share price movement and make predictions. I had showed how when a shorter term moving average intersects a long term moving average from below then it is a bullish signal. When a shorter term moving average intersects a long term moving average from above then it is a bearish signal. Here we will examine some share price movements and their moving averages and see whether we can make reasonable predictions.

Figure 1

Let us take the example of Ajanta Pharma. In Figure 1 200 Day Moving Average (DMA) is the blue line, 100 DMA is the green line, 30 DMA is the purple line and 10 DMA is the red line. The shorter MA follows the data closely as compared to a longer MA. When the 10 DMA flattens out at 1, the 30 DMA shows the dip later at 2, followed by the 100 DMA at 3 and 200 DMA just flattens out. So a shorter term MA pulls a longer term MA, and there is a drag involved.

As the 10 DMA intersected the 30 DMA from below around mid March 2011 (A), as expected the market turned bullish. Further this got strengthened at B when the 100 DMA intersected the 200 DMA from below. However, note that at that time the 10 DMA has started moving downwards, which indicates a reversal in fortune. All these facts have to observed to make predictions regarding future movement in prices. We need to wait to see whether the 10 DMA does intersect the 30 DMA from above. Then we would say that the prices are going to fall shortly.

Consider the example of Federal Bank as given in Figure 2.

Figure 2

The 10 DMA (red) intersecting the 30 DMA from above at 1 led to the downward journey which got strengthened when the former again intersected the 100 DMA (green) from above at 2 and subsequently the 200 DMA (blue) from above at 3. The reverse happened in 4, 5 and 6. In 7, 8, and 9 the 10 DMA is moving above and below the 30 DMA without majorly affecting the 100 DMA and 200 DMA. The share prices of the company, if we observe from the figure, are moving in a range. We can expect the prices of this company to remain range bound, which implies that this is a period of consolidation. If there is no fundamental news from the company, then we may not see a breakaway. Prices may actually fall as shareholder interest wanes.

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