I have been helping my 5 year old daughter learn trading, and before our most recent lesson I was struck by the need to give her the most amount of benefit with the least amount of complexity and effort on her part.

So I racked my brain to think of what was the most important trading lesson I could teach her.

What I came up with is probably the single most powerful signal in technical analysis… it is also one of the simplest to understand and it works across all markets.

It provides a very significant edge, separates high volatility dangerous periods from low volatility safe periods to trade and it keeps you trading in the direction of the primary trend.I wanted to do this because I wanted to give her something she could understand and use to  make good decisions. I wanted to give her a platform with a real edge from which she could refine and add other concepts that could really start to make money for her… or anyone else.

So what is the most powerful signal in technical analysis?

I explained to her that the 200 day moving average is the best way to tell you if a stock is going up or down. I explained that if the price is above the moving average then it is probably going up and if it is below the 200 day moving average then it is probably going down… but the benefits are actually much deeper than they sound.

Learn Stock Trading With My 5 Year Old—Enlightened Stock Trading

Learn Stock Trading With My 5 Year Old…The Most Powerful Indicator in Technical Analysis

She is only 5, so the first thing I did was explain what an average is (you can see this at the top of the page in the photo below). That made sense to her. I wrote the numbers but she came up with the answers.

Then I asked her if the price is above the average does she think it might be going up or down – She answered “Up!”. 

I asked her if it is below the average does she think it is going up or down – She answered “Down!”.

She already knows that you want to buy something that is going up and sell something that is going down…

Learn Stock Trading — 200 Day Moving Average On A Stock Chart

 

 

 

The 200 day moving average helps make it pretty clear whether the stock is trending up or down.

Now she knows you only buy when it is above the average and it if drops below the average you sell. Is this enough for her (or anyone else) to trade profitably? …No…  

But is it better than random – YES!

Is it an important long term setup – YES!

It is a concept that everyone should understand – YES!

Simple trading lessons are often the best

Buy things that are going up and sell things that are going down sounds obvious – after all my 5 year old daughter now understands this concept clearly.

But how many people have held onto stocks when they are falling? How many people lost their shirt in the 2000 tech bubble burst or the 2008 global financial crisis or the China stock bubble burst in mid 2015?

The fact of the matter is that so many average (loss making) investors buy stocks that they think should go up… but that are not actually going up. So they lose money.

The same average investors hold onto stocks that they think should not be falling… but that are actually going down the toilet. So they lose money.

The same indicator keeps you out of volatile and noisy markets

We all like to have a portfolio that goes up smoothly right? Well I certainly do – it seems like a rational trading goal to me.

If you look at the volatility of stocks that are above the 200 day moving average and compare it to the volatility of stocks that are below their 200 day moving average, you will find something amazingly powerful.

Stocks that are below their 200 day moving average are both less likely to move up on any given day AND they are more volatile compared to stocks that are above their 200 day moving average.

Don’t believe me? Check out these figures for the ASX200 Stock Index – they are quite astounding:

Indicator Setting Average % Change Standard Deviation
C<200MA 0.01% 1.36%
C>200MA 0.03% 0.76%

This shows that when the index is above the 200 day Moving Average, the average change in price from the close to the following close is positive (0.08%), and the volatility (measured by standard deviation of close to close changes) is almost half the volatility of when the index is below the 200 day moving average. This is over data from 1993 – 2015.

The results are also significant for the S&P 500 Index:

Indicator Setting Average % Change Standard Deviation
C<200MA -0.01% 1.58%
C>200MA 0.04% 0.88%

And it also holds true for individual stocks like Apple (AAPL):

Indicator Setting Average % Change Standard Deviation
C<200MA 0.07% 3.34%
C>200MA 0.14% 2.75%

So my daughter now has a simple tool that allows her to simply select stocks that are likely to go up more and reduce the volatility of her portfolio at the same time.

Side note: My daughter is not actively trading yet…but she is itching to start. I promised to fund her trading account with $10k (enough money to start trading stocks) as soon as she has learned how to trade in stocks thats enough to be profitable. She is in Kindergarten now, and I think she will be trading by the time she is in Year 1.

Simple technical analysis tool – Awesome powerful results!

There is just no excuse for holding onto losing trades and letting them punish your account. If you are holding onto anything that is below its 200 day moving average then you should really have a good hard look at it!

I am sure that many people hold onto stocks that are tanking because they don’t know how to decide when to get out, so they resort to closing their eyes and hoping it will go back up. We have all done this, I certainly have in the past.

Having traded successfully for so many years now, my solution is simple – if it is going down, don’t own it (or sell it short). How do you know if it is going down? There are many ways to tell if it is going down, but one of the simplest is if the closing price is below the 200 day moving average then it is going down!