Moving averages are a powerful tool for long-term investors looking to identify stock trends and confirm buying opportunities. While many traders use moving averages for short-term signals, they can also serve as a valuable indicator for buy-and-hold investors focused on fundamental analysis and value investing.
In this article, we’ll break down the two most commonly used moving averages:
- Simple Moving Average (SMA) – A straightforward average of past stock prices over a specific time period.
- Exponential Moving Average (EMA) – A moving average that gives more weight to recent prices for faster responsiveness.
We’ll explore how long-term investors can integrate moving averages into their investment strategy, common misconceptions, and real-world examples using companies like Apple (AAPL) and Microsoft (MSFT).
What Are Moving Averages?
A moving average (MA) is a mathematical calculation that smooths out stock price fluctuations by averaging historical prices over a set period. This helps investors identify long-term trends rather than getting distracted by daily price movements.
There are two primary types of moving averages:
1. Simple Moving Average (SMA)
The SMA calculates the average closing price of a stock over a given period. For example, a 200-day SMA adds up the closing prices of the last 200 trading days and divides by 200.
A moving average (MA) is a mathematical calculation that smooths out stock price fluctuations by averaging historical prices over a set period. You can read more about how moving averages work on Investopedia.
Why Use SMA?
- Helps identify overall market direction.
- Removes short-term volatility to reveal long-term trends.
- Frequently used by investors to confirm bullish or bearish sentiment in a stock.
Example: If Apple’s (AAPL) stock price is consistently trading above its 200-day SMA, it suggests a strong long-term uptrend.
2. Exponential Moving Average (EMA)
The EMA is similar to the SMA but places more weight on recent prices. This makes it more responsive to current market movements.
Why Use EMA?
- Reacts faster to recent price changes compared to SMA.
- Helps investors confirm shifts in stock momentum.
- Commonly used for identifying short- to medium-term trends.
Example: If Microsoft’s (MSFT) 50-day EMA crosses above its 200-day EMA, it creates a golden cross—a bullish signal that suggests potential long-term growth.
How Moving Averages Align with Buy-and-Hold Investing
While moving averages are commonly used in trading, they can also be a helpful confirmation tool for long-term investors. Here’s how:
1. Identifying Strong, Long-Term Trends
A stock consistently trading above its 200-day SMA often indicates a strong business with growth potential. Investors can use this as a secondary check before buying.
Example: Before investing in Johnson & Johnson (JNJ), a value investor could check if its stock price has historically remained above the 200-day SMA, indicating long-term strength.
2. Avoiding Value Traps
Sometimes, a stock appears undervalued based on fundamental analysis, but its long-term moving average suggests ongoing weakness. Checking the 200-day SMA can help investors avoid buying a stock that’s in a long-term decline.
If a stock’s price is consistently below its 200-day SMA, it may indicate deeper problems that require further research.
For more on how to properly value a stock, check out Advanced Valuation Techniques.
3. Supporting Buy-and-Hold Decision-Making
Buy-and-hold investors typically focus on fundamentals such as earnings, cash flow, and intrinsic value. However, moving averages can serve as a confirmation tool to reinforce their investment decisions.
For a deeper dive into value investing, read The Basics of Value Investing.
Best Moving Averages for Long-Term Investors
Buy-and-hold investors should focus on longer time frames to avoid short-term noise. Here are the key moving averages that align with value investing:
✅ 50-day SMA: Useful for spotting medium-term trends.
✅ 100-day SMA: A longer-term average that shows major stock movements.
✅ 200-day SMA: The most important moving average for long-term investors.
Case Study: The 200-Day SMA in Action
Let’s look at Apple (AAPL) as an example. If Apple’s stock is consistently trading above the 200-day SMA, it signals long-term strength. But if the stock dips below the 200-day SMA, investors may want to investigate whether it’s just short-term volatility or a sign of deeper problems.
Common Misconceptions About Moving Averages
❌ 1. Moving Averages Predict Future Prices
Moving averages do not predict where a stock will go. They only show past trends and should be used as a confirmation tool alongside fundamental analysis.
For more on analyzing stock fundamentals, check out Stock Fundamentals Explained.
❌ 2. A Golden Cross Always Means Buy, and a Death Cross Means Sell
- A golden cross (when the 50-day EMA crosses above the 200-day SMA) is considered bullish, but it doesn’t always guarantee future gains.
- A death cross (when the 50-day EMA crosses below the 200-day SMA) is often seen as a bearish sign, but some stocks recover.
Long-term investors should always consider company fundamentals first.
Step-by-Step Guide: Using Moving Averages in Your Investment Strategy
Want to integrate moving averages into your buy-and-hold strategy? Follow these steps:
1️⃣ Choose a Strong Company Based on Fundamentals
- Look at earnings growth, debt levels, and valuation metrics.
- Use resources like SEC filings (SEC.gov) and company reports.
2️⃣ Check the 200-Day SMA
- If the stock price is consistently above the 200-day SMA, it suggests long-term strength.
3️⃣ Compare the 50-Day and 200-Day Moving Averages
- A golden cross (50-day EMA crossing above 200-day SMA) can reinforce a bullish outlook.
4️⃣ Monitor the Stock Over Time
- Don’t make decisions based only on moving averages. Use them as a secondary indicator.
5️⃣ Avoid Short-Term Trading Traps
- Moving averages should not be used for frequent buying and selling.
Before buying, ask yourself these key questions.
You can easily check the 200-day SMA of a stock using free charting tools like Yahoo Finance, which allow investors to overlay moving averages on stock charts.
Final Thoughts on Moving Averages for Long-Term Investors
Moving averages, particularly the 200-day SMA, can be useful tools for buy-and-hold investors. While they shouldn’t replace fundamental analysis, they can help investors confirm trends, avoid value traps, and stay focused on long-term success.
Remember: Invest in companies, not just stock price trends.
Key Takeaways:
✔ SMA smooths price movements, while EMA reacts faster to price changes.
✔ The 200-day SMA is the most important moving average for long-term investors.
✔ Moving averages should be used as a confirmation tool, not a predictive one.
✔ Always combine moving averages with fundamental analysis to make sound investment decisions.
Happy Investing!