How to Effectively Use a Moving Average Confirmation Rule

On Friday, the major indices, including the small-cap Russell 2000 (IWM) and S&P 500 (SPY) closed underneath their 50-day moving average. However, on Monday, both reversed and ended the day above their 50-DMA. With Friday’s weak price action, any bearish traders who decided to short these indices based on a break of the 50-DMA would now be underwater in their trades.

For this reason, we follow a simple rule to confirm price breaks under or over major moving averages. The rule is to wait for the price to close for 2 consecutive days under/over the 50-DMA. Often, price can temporarily dip or clear a pivotal MA before reversing.

With that said, no trading rule is perfect, and you risk getting a subpar entry or sometimes completely missing the trade if there a large gap in price the next day.However, in the long run, it will pay for itself, as there are many times when price action will trap traders before running in the opposite direction.

Some quick tips to make the rule more powerful from a trading perspective would be to watch how strong the 2 closes are and if they stay near the 50-DMA or continue to push away from it. A second close near the MA shows that price action could still be indecisive and therefore waiting for might be the next best plan. This can help time your entries to make sure you do not get chopped or whipsawed in the market.

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ETF Summary

  • S&P 500 (SPY): Filled gap to 419.23. Support 414.70.
  • Russell 2000 (IWM): 221.13 support.
  • Dow (DIA): 332.68 support.
  • Nasdaq (QQQ): 342.80 pivotal area.
  • KRE (Regional Banks): 64 support.
  • SMH (Semiconductors): bounced off 244.77 the 50-DMA.
  • IYT (Transportation): 254.65 support.
  • IBB (Biotechnology): Needs to hold 159 area.
  • XRT (Retail): Did not confirm caution phase. 91.57 support.

Forrest Crist-Ruiz

Assistant Director of Trading Research and Education