Despite the wheeler-dealer image of their profession, most successful stock traders have had to learn how to live in the past, present and future simultaneously. A displaced moving average (DMA) can be a useful tool in seeking that multi-layered perspective.
Moving averages in general are technical analyses designed to remove aberrations known as “noise” – a rumor or an event -- that might influence the price of a stock in the short term. This is done by charting the progress (or retreat) of a stock over a set period of time and calculating an average that smooths out random fluctuations.
For example, a stock price may rise or fall precipitously based on a rumor that the company is about to be sold, depending upon whether the alleged sale reflects a position of strength or weakness. The next day, if that information is exposed as false, the price may almost immediately readjust. Moving averages iron out those peaks and valleys. If the arc of a moving average graph crosses either above or below the longer history of a stock, it can be an indicator of the security’s positive or negative momentum.
The problem with a standard moving average, however, is that it lives in the past and often lags behind trends. Displaced moving averages seek to extend the trend into the future, based on the existing price trajectory. Or, the moving average can be regressed into the past to provide a longer look at what seems to be a volatile offering.
Amateur investors tend to look at the market as a whole. A displaced moving average might demonstrate that a particular stock can be expected to continue moving upward despite a weakening market, or the reverse. Given the growing international interconnectedness of stock prices, some prominent speculators, such as Louis Mendelsohn, have even developed simultaneous displaced moving averages to reflect the effect different international markets may have on each other.
Of course, even the most complex displaced moving average graph is only mortal, prone to the vagaries of the future. Even a stock said to be a “mover” may be on the verge of being ambushed by an unforeseen calamity. The bursting of the dot.com bubble and the domino effect triggered by the home mortgage crisis would not have shown up on moving averages estimated six months earlier.
Still, any tool -- like the displaced moving average -- that will tune out the daily clamor of the financial markets can be useful if taken at face value.
