Email of the day (2
Comment of the Day

October 29 2013

Commentary by David Fuller

Email of the day (2

On determining overextension relative to the 200-day MA
"Forgive me if have covered this question in the recent past, but I was hoping you would elaborate on what criteria you employ to determine the over extension of a stock price relative to the 200 day moving average. Within a range, what percentage of the 200 day MA does the current price need to be for you to consider it overextended? Thank you very much for your insights."

David Fuller's view Thanks for your question as this is an important subject for most subscribers. It is mainly relevant in trending markets, up or down. The 200-day MA is used by this service as an approximate trend mean for the medium term. However, markets are often emotional so a period of euphoria will cause the price to surge higher above the mean than may have occurred previously. Conversely, a panicky phase will cause it to accelerate well below its MA mean.

Try to think in terms of trend consistency, rather than percentages. A trending market will reveal a number of consistency characteristics caused by the buying and selling activities of the people who are fuelling the trend. You will soon learn to identify these objectively as the trend progresses. The clear overextensions relative to the MA, up or down, are usually unsustainable beyond the short-term, with the rare exceptions of takeovers or bankruptcies.

You will see this if you look at weekly charts which also include the 200-day MA, and Eoin and I post plenty of them. You can start with the example in the first email above, where I identify the overextensions and you can see what happened subsequently. You can also see the Unilever example which I discussed on 2nd October, under the heading: Using factual technical analysis to gage risks and opportunities in global Autonomies.

The principle is simple. If a market rises strongly buyers will back off for a while and some may take profits. Conversely, if a market falls sharply, shorts may decide to take profits and buyers may become interested if the decline looks climactic.

You can be sure that analysing trends, not least for markets in which you are interested, will be an important subject at Eoin's upcoming chart seminars listed below.

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