An ax can be either a useful tool or a dangerous weapon. In stock charts, the 50-day moving average has a similar dual nature.
XThe 50-day moving average takes a stock's prior 50 daily price closes and averages them. Do this every day in an upward-trending stock, and you'll get a line on a chart that runs below the stock's price bars while smoothing out the jumps and buckles.
The line serves a startling number of uses. When a stock is basing, a cup base with more than half its bulk above rather than below the line is a sign of health. Another sign of a stock's strength: a flat base that finds "support" at its 50-day line.
What is support? Institutional investors often use the 50-day or 10-week line as a reference point, stepping in to add shares to their positions when a stock pulls back to the moving average. This buying creates upward pressure — or price support — to help keep the stock's prices above that moving average.
Spotting Follow-On Buy Points
This is why rising stocks often rebound from their 50-day lines, turning brief pullbacks into follow-on buying opportunities. It is also why 50-day and 10-week moving averages tend to cradle advances that can run across many months.
On the dangerous side, a rallying stock that collapses below 50-day support in heavy volume is often sending a sell signal. Once below that line, institutional investors may use the 50-day line to mark a sell level. Short sellers may use the line as a level at which to sell shares short.
These forces create a level of resistance. Stocks often need a large boost of buying power to muscle back above their 50-day lines after losing that level of support.
There are other, similar moving averages. Most common is the 10-week moving average. This line tracks a stock's weekly closes over the prior 10 weeks. It generally tracks fairly close to the 50-day line. So if you are reading a daily chart, use the 50-day line. If you're analyzing a weekly chart, use the 10-week.
There is a similar relationship between the long-term 200-day and 40-week averages. On a daily chart, use the 200-day. On a weekly chart, it's the 40-week line.
The 50-Day Moving Average And ORLY Stock
In an uptrending stock, the 200-day and 40-week averages will generally track well below the 50-day and 10-week lines, respectively.
When a stock consolidates its gains for an extended period, the 50-day or 10-week line will sometimes cross and pass below the longer-term averages.
O'Reilly Automotive (ORLY) broke out of a nine-week flat base at 94.98 in the week ended Feb. 8, 2013. The base formed near or above its 10-week moving average.
The auto parts chain climbed 64% through February 2014. It ran up neatly and followed the rules of 10-week line etiquette.
The stock found support near or at the line (1) twice within several months of the breakout, offering entry points for holders to buy more shares.
O'Reilly slipped below the line in light trade in September 2014, but it was not a sell signal. The rally continued through the fall of 2015. In early 2017, the stock began a deep correction, resetting the base count.
This column originally ran in the May 15, 2015, edition of IBD. Find Elliott on Twitter: @IBD_aelliott
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