Herc, Here is the psychology of MA.
To understand why MA act as support and resistance you need to understand the psychology behind it and the significance of breaking a MA to the downside or upside. Dr. Alexander Elder in his book titled "Trading for a Living" and on page 122 discusses the "Market Psychology" of MA. Here is what he says:
Each price is a snapshot of the current mass consensus of value. A single price does not tell you whether the crowd is bullish or bearish - just as a single photo does not tell you whether a person is an optimist or a pessimist. If, on the other hand, someone brings ten photos of a person to a lab and gets a composite picture, it will reveal that person's typical features. If you update a composite photo each day, you can monitor trends in that person's mood.
A moving average is a composite photograph of the market - it combines prices for several days. The market consist of huge crowds, and a moving average identifies the direction of mass movement.
The most important message of a moving average is the direction of its slope. When it rises, it shows that the crowd is becoming more optimistic - bullish. When it falls, it shows that the crowd is becoming more pessimistic - bearish. When the crowd is more bullish then before, prices rise above the moving average. When the crowd is more bearish than before, prices fall below a moving average.
Back to me now. When the prices are below 200 dma then it means the long term trend is down or that the stock is in a down trend. When it breaks decisively above the 200 dma it shows that the crowd are bullish on the stock and that the stock is now in an uptrend. There are books on the subject and I can talk forever about it. For now, this should give you an idea behind the mass psychology of MA. As far as to why they act as support and resistance, I will leave that to another memo.
Good trading,
Christopher |
