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MOVING AVERAGES


Is It "Now Time" For Nokia?

09/07/00 03:12:05 PM
by David Penn

Moving averages, envelopes and more moving averages provide questions, answers and more questions.

Security:   NOK
Position:   N/A

There is an axiom surrounding moving average combinations that says when a shorter moving average line crosses under a longer moving average line, the horizon gets just a little bit darker for the underlying stock. If that is the case, then Nokia (NOK) may be in store for a September that is as bruising as was its July. In July, Nokia suffered a downside breakaway gap that cost the company's shares 10 points on the initial plunge and another seven before the ride down was done. Since an early August low of about 37, Nokia worked its way back up to close at 45 by the end of the month. But Nokia's near-term upside potential appears to be limited by a conspiracy of moving averages, the 50- and 200-day in particular, which suggest declines sooner than advances.

Why so? The idea of a moving average is to smooth out the whipsaws and gyrations in price action in order to gain a clearer picture of the trend. Moving averages are computed by adding up a series of price closes and then dividing that total by the number of price closes in the series. For example, a 200-day moving average would be computed by adding up the previous 200 daily closes and dividing that number by 200. Each day a new moving average is computed, forming a moving average line that tracks the trend in price movement, albeit in a trailing fashion. Analysts look for prices to cross above their moving average lines before issuing bullish interpretations, and for prices to cross below their moving average lines before analysts grant a bearish reading on the price action. However, moving averages can effectively be used in combinations, with convergence between longer and shorter moving averages acting as signals for buy and sell opportunities. Because a shorter moving average emphasizes more recent (though not necessarily longer lasting) price movement, analysts consider it a bullish sign when shorter moving averages cross up over longer lines. Conversely, it is considered bearish when the shorter moving average line crosses down under a longer moving average line.

1. Shorter moving average crossing under longer moving averge is bearish. 2. Prices crossing over 50-day moving average anticipate possible flattening of intermediate trend. Is the upside cross of 200-day moving average far behind?
Graphic provided by: Window On WallStreet.
 
One refinement on moving average combinations is the moving average envelope, the simplest of which will shift a moving average line a specific percent above and below the main moving average. Usually this will be between 3% and 4%. By putting the price action in an envelope, the analyst has created a picture wherein the majority of the price values will tend to fall within the envelope. Those prices that lie outside of the moving average envelope will suggest that either those prices are aberrant and will correct back inside the moving average envelope, or those prices are suggestive of where the trend is actually headed, possibly indicating a significant trend change.

Nokia provides an opportunity to see moving averages at work. Note the convergence between the shorter, 50-day moving average and the longer, 200-day moving average that occurs in late August. This alone would begin to suggest a bearish situation and, given Nokia's recent woes, a bearish reading would certainly make sense. Turning toward the moving average envelope, which consists of a 9-day moving average with two moving averages plotted at a 2% deviance, it is also easy to note the tendency of the price to pull back to the average. Extreme lows during the last days of June were corrected at the beginning of July, and a similar phenomenon seemed to have been in effect at the end of July and beginning of August. However, at the end of August, upside price extremes (as shown on the moving average envelope) were occurring, and with stronger closes near the highs, as well. Does this mean that Nokia is headed for more upward movement, possibly reversing its recent declines? Or are these moving average envelope breakouts simply false moves that will be corrected in September?

One way to watch Nokia as a possible trend reversal play is to see how the price reacts as it approaches and tests its 50-day moving average line. As prices converge and cross the 50-day moving average line, the average is likely to flatten out somewhat, taking some of the downward momentum out of Nokia's intermediate trend. This is good news for Nokia. As it is, whole prices attempt to cover the downside late July gap. And who knows? With the 50-day moving average line breached, is the upside cross of the 200-day moving average far behind?



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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