Moving Averages
Background
Christen Baldwin is interested to evaluate the potential return on the strategy of using moving averages to forecast the direction of a particular stock’s price. Ms. Baldwin has selected a stock to study, and the attached excel file provides the monthly closing and moving average data and chart of the selected stock. From these data, her intent is to compare the profit or loss from various investment strategies.
1. If Baldwin limits transactions to buying and subsequently selling on the various
signals, when does Baldwin make her first purchase? (Assume all transactions are in units of 100 shares and there are no commissions.)
Mayo (2008) provides that “a moving average is an average computed over time”.
The graph attached to this report provides the individual stock price by date, and the moving average. These two lines are plotted on a graph. At several points the two lines cross. Those who use the moving averages approach to forecast stock prices place emphasis on such crossovers, believing that it is indicative of a change in the direction of the market or specific stock price (Mayo, 2008, p.490).
When a stock’s price equals the moving average, that is a signal to sell or buy. If after a period of declining prices the stock price rises and equals the moving average, that is a signal to buy. Given the foregoing, the first crossover signal occurs in August 2000. The signal is observed by observing the difference in the 6-month moving average from 8.48 in Jul 2000 to -3.02 in August. As the moving average moves from a positive number to a negative number, the signal is a sell signal, indicating a change in the direction of the stock’s price. The next crossover that occurs is in December of 2000, where the moving ...