Swing Trading | Short-Term Moving Averages Can Help Cut Stock Losses Quicker | IBD digital | 2016 article

 Minimizing losses is a key element of successful trading. In addition to choosing logical areas of support as your “line in the sand” to cut your loss, moving averages can help reduce losses when a stock’s trend turns against you.

For IBD, the moving average that gets the most attention is the 50-day moving average. It’s often used as a gauge of whether a stock is getting support from institutions since it reflects the average price paid by investors over the past 50 days of trading.

As with most things in a swing trading style, similar trading rules may be applied but with a shorter time frame. With the expectation that most trades will last five to 10 days, the 5- or 10-day moving average is more appropriate to use.

A stock that crosses below a short-term moving average -- after closing above the line -- may be giving an early signal that its uptrend is in jeopardy. If it happens quickly intraday but recovers, that isn’t as worrisome. Waiting until the end of the day is a good way to avoid these inevitable shakeouts.

However, a stock that looks weak at the end of the day, trading decisively below its moving average and near the lows of the day, can be sold before the close, especially if volume accompanies the drop.

Take Tech Data Corp. (TECD), which was added to our Swing Trader product on a reversal March 29 (1). Volume was tracking at its highest level in three weeks (2) as the stock looked like it was going to take out the previous day’s high. The price had a larger range on the reversal day with a low of 74.11 and a high of 77.42, more than 4% from the low to the high. Even getting in right at the buy point left a larger stop-loss percentage using the low of the reversal day. Higher risk on the trade should often be accompanied by a smaller position size to mitigate the risk to your portfolio.

By April 1, the stock had made some progress and closed strongly above the 5-day moving average only to drop back below the line the next day (3). Even though the stock hadn’t undercut the low of the reversal, it was a sign that the stock was likely to show weakness in the short term and so it was removed from Swing Trader with a loss just over 1%.

Two days later Tech Data undercut the low of the reversal at its stop-loss price (4). Waiting that extra time would have resulted in a loss of nearly 4%. Getting out earlier and with smaller losses when you’re wrong can lead to significantly higher profits when you’re right.

Subscribers and trialists to Swing Trader can view the full details of this real-time trade, as well as the complete history of all trades, in the Past Trades section of Swing Trader. Free trials are available.