Thursday, December 28, 2006


Any taxpayer who invests in the stock market may want some method to get in and get out when the getting is good. There are a lot of technical and fundamental approaches to portfolio management. Warren Buffett uses the fundamental approach. I’m not as smart as the Oracle of Omaha, so I sometimes rely on moving averages to indicate trend changes. There are simple and exponential moving averages plus a lot of more arcane indicators. I go for the KISS principle, “Keep it Simple Stupid”.

Subscribe with Bloglines

Add to Google
Link to TAX MAN:
Link to other personal finance information

Add to My Yahoo!
To add to My yahoo use this (if the My Yahoo button wont work)
A simple moving average shows the average price over a certain number of days: To calculate it, just add the daily closing price for the number of days you want to use. To illustrate for five days the prices were 20, 22,19,14,18 These prices add to 93. The moving average for the five days would be 1/5 of 93 or 18.60. The concept is simple, but if you are using a 100 day moving average, you would have to drop the oldest day and add a new day every day, then re-add or adjust the total by the difference between the first and last day. Simple but tedious.

Simple moving averages are "jumpy." They respond twice to each piece of data - once when it is added, and again when it drops off. Having the moving average change when a price is removed is a bad thing. When a high price is dropped, the MA will most likely tick down. When a low price is dropped, the MA would probably tick up even if the price went up that day, but by an amount smaller than the value that was dropped.

The solution to the tedious calculations and the jumpy effect of the simple moving average is to use Exponential Moving Averages. The word “Exponential” makes it sound like it is more complicated, but it isn’t. There are two components to the Exponential Moving Average (EMA). To calculate the first component, you divide the number 2 by the number of days in your EMA PLUS 1. That is, to calculate a FIVE-day EMA you would divide 2 by (5+1) or 2 divided by 6 which would mean the first component would be 33.333%. The second component would be the remaining 66.667%.
So if your old EMA was 18.60 and the current price was 18. You would multiply 18 by .3333 and multiply 18.6 by .6667. The result would be 6 for component # 1 (today’s price of 18). The other component would be 12.40. You would then add 6+12.4 and the new EMA would be 18.40.
FINDING THE EMA WITHOUT CALCULATING IT: It It sounds easy---if you have the old EMA. BUT it would take a lot of calculating to come up with the old EMA if you had to calculate it. The best solution is to look it up the easy way. To set it up go to .
Enter a symbol for some stock, mutual fund or ETF.

To illustrate, I selected SPY (An Exchange Traded Fund that tracks the S & P 500)
After you enter the symbol and click GO, you will be taken to a screen with the price and other information.

On the left side of that screen you will see ‘charts’.
You may have to do something now or later to get the “beta” version. Do that, and when you move to the screen with the chart, click “Technical Indicators
A screen will pop up. Click EMA. Another pop-up asks you to enter the number of days. I entered two choices: 30 days and 50 days.
Now the chart will show the actual price of SPY, the 30-day EMA and the 50-day EMA in different colors on the chart. Also, you can read the numeric prices and EMAs if you drag your cursor over the chart.
The chart shows the prior day’s close. The closing price, the 30-day EMA and the 50-day EMA are all shown, color coded to identify each.
When I did this at about 9:30 CST Dec 28 the Current price was 142.40, the Dec 27 (yesterday) closing price was 142.51. The 50-day EMA was 130.4985 and the 30 day EMA was 140.83.


Although none of this tells you what the stock will do in the future, it tells a lot about the trend. The price is ABOVE both moving averages. Also the shorter 30-day EMA was above the longer 50-day EMA. This means the stock is uptrending.
If you believe “the trend is your friend” then you would consider it an opportune time to invest in SPY. BUT don’t go out and buy it on this alone. The other day, I personally, decided to dump it and switch to some better performing investments. I may have been right or I may have been wrong. I’m ahead right now But tomorrow may tell another story.
Trends are NOT the only way to go about investing. Jumping in and out of stocks based on moving averages, especially short-term averages, often causes you to sell when it drops, only to see it rebound and you buy back at a higher price. This is called ‘getting whipsawed’.

Some investment advisors use the 100-day moving average with a few modifications of their own to generate their buy/sell recommendations. I think the length of the moving average needs to be adjusted based on how long a bull market or bear market has been in existence.
After a long upswing, you know there is going to be pay-back time and the market will drop—the bigger they are, the harder they fall-- as the bursting of the dot com bubble indicated a few years ago.

After a big decline, the market eventually recovers, so if the market has been going down big-time for a year and finally moves above a 30-day EMA, then you would probably be safe in buying since the trend may have changed. This would get you in ahead of those who waited for the price to go above the 100-day EMA.

NOTE: This is NOT investment advice. There is no sure thing and no ‘indicator’ is always correct. But if you do want to use any sort of technical indicator for investing, I would suggest that you keep it simple. Many believe in Elliott Waves as an indicator. In my opinion, no one can interpret these ‘waves’ until after they have run their course and then can be interpreted with 20/20 hindsight. Wave counters would violently disagree with me. Maybe they know something I don’t know, but I wouldn’t know how to begin counting those magic waves.

Link to IRS forms and publications:
Subscribe with Bloglines
Add to Google
Add to My Yahoo!

This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

No comments: