Some good advice, this…
A simple yet effective trading rule is to stay on the right side of the 200-day moving average. If you always own a stock when it is above this key indicator, and sell it when it drops below, you will be on the right side of all big moves.
As is often the case with simple rules, the execution may present some challenges. For an example, let’s check recent trading in Apple Computer, Inc. (AAPL).
I am using the popular 200-day exponential moving average and looking at the last two months so that we can highlight the key period. You can see that the stock closed just above the key level on Friday, June 17th. The stock collapsed on no news on the following Monday, as those adhering to this indicator chose to sell. Many other traders, understanding what was going on, stepped back from the trade. By late morning even CNBC mentioned what was going on.
How did this work?
If your rule is to buy and sell on a closing basis, you sold at 315 and bought back at 325. My guess is that many did much worse. Those panicking on the sell date might have sold as low as 310. Those who sold may have decided to defer the repurchase. People hate to buy back a stock at a higher price, and they hate to chase. Those not acting right away may still be waiting to repurchase their shares, now trading in the 340s, nearly ten percent higher than the sale price.
It is important to have a disciplined system, especially including a rule for selling when something has not worked. I prefer to sell on a fundamental basis. When the company’s business changes, when events change, or when my thesis has proven wrong, I accept the mistake and move on. An advantage of this approach is that I do not have millions of others competing to sell at the same time.
The 200-day moving average rule is one way of improving over buy-and-hold investing, but not the best. If you are going to follow this method, discipline is essential. This is especially true in a volatile stock like AAPL and in volatile times like the past few weeks.
My guess is that many sellers of AAPL have yet to repurchase the stock. When you validate a system through testing, you had better follow the rules in your actual trading.
While I have written this article in terms of AAPL, the same argument could be made for the QQQ’s or the major market averages, all of which have been trading at this important technical level.