What is the best way to compare moving averages? Is this just a statistical exercise or can the idea of moving averages be an investment strategy in itself?
For better or worse, the answer to these questions is a resounding no.
There is no question that the moving average is an invaluable investment tool as it allows us to understand what happened during the past 12 months. However, it also creates a false impression of what should be happening in the future.
The reality of the situation is much different than what we are lead to believe when we look at the moving average.
The reason why an investor who buys at a moving average based on the previous 12 months (or at the average price of the most recently active security) should be in a hurry to buy is because he/she may receive a very large amount of exposure to the current stock market and has made multiple trades in an attempt to “buy in” to a certain level. While we think about how we can best leverage this strategy, we should also consider how we will be able to benefit from the position.
Moving averages should not be solely considered in isolation from investment strategy.
As with all the financial products, the use of the moving average to judge stock price movements is not an entirely accurate one.
The most accurate way to track the performance of any stocks is to do a price/earnings (P/E) comparison, since that is most directly impacted by buying and selling moves as prices are higher or lower.
So, what is the difference between the P/E and the moving average calculation?
The P/E or “price to earnings” calculation compares the current market value of a stock to what it “should” be. While P/E figures take into account any profits or losses which may have occurred in the future, they are not based on the movements in the stock itself.
For example, let’s say our moving average stock price is $100 and our hypothetical firm sells it at $100. If the stock subsequently rises to $110, we can conclude that we sold at a discount of 25% since our share price increased by 25%. But, it is not our stock price which is now higher (we sold at 85 cents!).
When considering the P/E calculation, the best way to learn the stock price is to look at the P/E difference, and vice versa.
The move in price for the market is calculated by dividing the actual price by