Traders often use moving averages (MAs) to define the direction of a trend.
If prices are above the MA, then the trend is up. And if prices are trading below the MA, then there’s a downtrend.
The five-day MA is used for short-term trends, usually meaning periods of one to three months.
Long-term trends can be defined with the 200-day MA. This timeframe covers periods of a year or more.
The 50-day MA can be used to define the intermediate-term trend. This timeframe can be defined as about three to six months.
And last week, an important 50-day MA came into play.
Why the 50-Day MA Matters
Right now, many of the stocks that led the bull market over the past year are near or below their 50-day MA.
At the end of last week, for example, the iShares Russell 2000 ETF (NYSE: IWM) was below its 50-day MA. Leading tech stocks fell below the average during the week, but many recovered to end trading for the week above it.
The 50-day MA can be used as a trading strategy. In the past, avoiding IWM when it was below this MA dodged significant losses.
Over the past 10 years, IWM delivered an average annual gain of 12.9%. However, owning the exchange-traded fund (ETF) only when it was below its MA gained just 7.3% a year.
Using the 50-day MA as a sell signal means that traders reduce their exposure to stocks as bear markets are beginning.
A Warning of the Next Bear Market
All major stock market averages are testing their 50-day MA. If they all fall below that level, then we will almost certainly be in a bear market.
The official announcement of a bear market will be made after the indexes fall by more than 20%. But by that time, investors will have large losses in their portfolios.
Breaks below the 50-day MA are warning us that a bear market is possible. That could be a signal to stop buying aggressive stocks, or to switch from growth to value strategies.
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Editor, One Trade