To say the least, 2022 was not an easy year for investors. Many stocks that were darlings of 2020 and 2021 have given back unbelievable sums of their gains over the past year, some now even below pre-COVID levels. TSLA stock sank around 70% alone, and other prominent names in tech like META, ZM, PYPL, NFLX, and many others are also impacted similarly. A major culprit is that inflationary pressures on the economy forced the FED to pivot and suddenly shift to higher rates in a very short period of time. The traditional mentality of buying and holding stocks for dear life (also referred to as HODLing) clearly did not pay off in the past year. However, believe it or not, following just one simple technical indicator could have entirely helped you avoid these large drops, or actually profit from them instead.
You might be wondering: How can one technical indicator alone be so useful and accurate? The answer to this question is simple: because big money uses it. When we're talking about big money, we're talking about the large institutions and funds that manage several multi-billion dollar positions simultaneously. Do these firms report losses of 30-50% per year after large down years like we just had? Absolutely not, as doing so would decimate their value proposition.
So, you've waited long enough to learn what indicator this is. To begin explaining it, let's start with a quick photo of Tesla's daily chart:
As you can see, we have TSLA stock charted along with a solid blue line. What's something that you can quickly notice from seeing this chart? Well, the stock price is certainly much more stable and generally in an uptrend when it's above this blue line, and much more volatile and troublesome whenever it falls below this blue line. This blue line is actually the 200-Day Moving Average, which is essentially an average of the last 200 days of the stock's closing price. When this 200-Day moving average is curving up, that's typically a good sign that the stock is appreciating and it's a good time to be long this name. However, when the price falls beneath this 200-Day moving average and it starts curving down, that's typically when the pain is only getting started.
In this chart, the price does briefly drop below the 200-Day moving average on a few different instances. In mid 2021, early 2022, and then finally mid to late 2022. So the point of this is not to claim outright that the moment a stock falls beneath this level, you should immediate sell or short the name, because in the beginning it did come back a few times before it finally gave up in 2022. However, you can devise a set of rules around this indicator to protect yourself against these drops. One example of this could be: I'll sell if the stock drops 5 or 10% below its 200-Day moving average. Additionally, it's important to keep in mind that the direction of this moving average (whether it's curving up or down) is critical, because it's much more trustworthy when it's curved up rather than down. In fact, when the 200-Day is curved downward, we almost always prefer not to hold or be long the stock until it flattens or curves back up. This indicator alone can save you from some treacherous drops that can go as high as 50 - 90% from the highs. After you've lost 90% on any given position, you need that name to make a 1000% move up just to breakeven!
If you want to see a few more examples outside of TSLA, here are a few more:
Here's META Platform's Stock, which was clearly weakening around its 200-Day moving average all the way back in early 2022. This one could have also been avoided. The only other time it dropped below this level is around the COVID drop in 2020.
Here's a chart for ZM. Clearly a very volatile name, but the worst of the trouble didn't start until the last drop beneath its 200-Day moving average back in late 2021.
Lastly, here's a chart of NFLX, which similarly had its biggest drop with a declining 200-Day moving average that it dropped beneath. This is notably the only one on the list that is actually back above its 200-Day moving average, which may mean it could be time to get back in. Of course, unless the name drops back below this indicator.
If nothing else, the one point that you should take away from this is: This technical indicator does matter, and it matters a lot. Hedge funds use it, institutions like it, even traders use it for short to medium term trades. Just look at how crystal clear the red flags are when look back on it. We hope that this helped gain some perspective on how to be on the right side of a trade or investment in the future.
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