Traders often use moving averages (MAs) to define the direction of a trend.
If prices are above the MA, then the trend is up. And if prices are trading below the MA, then there’s a downtrend.
The five-day MA is used for short-term trends, usually meaning periods of one to three months.
Long-term trends can be defined with the 200-day MA. This timeframe covers periods of a year or more.
The 50-day MA can be used to define the intermediate-term trend. This timeframe can be defined as about three to six months.
And last week, an important 50-day MA came into play.
Why the 50-Day MA Matters
Right now, many of the stocks that led the bull market over the past year are near or below their 50-day MA.
At the end of last week, for example, the iShares Russell 2000 ETF (NYSE: IWM) was below its 50-day MA. Leading tech stocks fell below the average during the week, but many recovered to end trading for the week above it.
The 50-day MA can be used as a trading strategy. In the past, avoiding IWM when it was below this MA dodged significant losses.
Over the past 10 years, IWM delivered an average annual gain of 12.9%. However, owning the exchange-traded fund (ETF) only when it was below its MA gained just 7.3% a year.
Using the 50-day MA as a sell signal means that traders reduce their exposure to stocks as bear markets are beginning.
A Warning of the Next Bear Market
All major stock market averages are testing their 50-day MA. If they all fall below that level, then we will almost certainly be in a bear market.
The official announcement of a bear market will be made after the indexes fall by more than 20%. But by that time, investors will have large losses in their portfolios.
Breaks below the 50-day MA are warning us that a bear market is possible. That could be a signal to stop buying aggressive stocks, or to switch from growth to value strategies.
That said, be sure to follow us at Smart Profits Daily, where we share tips and market insights you won’t find anywhere else.
Michael Carr, CMT, CFTe
Editor, One Trade