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Above-Average Investors Analyze Moving Averages

Few tools in the trader's workshop see as much active duty as the moving average lines.

These useful markers are charted over a stock's and come in many varieties. Most commonly used: the 10-week and the 50-day lines.

The two follow similar trajectories: the former on a weekly, the latter on a daily chart.

The 10-week average is the sum of a stock's weekly closing prices over the prior 10 weeks, divided by 10. A 50-day line sums up the 50 most recent days of closing prices and divides by 50.

Institutional investors who favor buying on price weakness often use the 50-day line as a baseline. When a stock's price eases, they step in to buy near the 50-day line. That buying fuels the rebounds used by investors as add-on opportunities.

A stock cutting below the 50-day line in serious is a warning. It is not an automatic sell signal, but alerts investors the stock may be weakening.

The 40-week and 200-day moving averages can also provide sell signals, albeit usually late ones.

Align Technology (ALGN) held closely to its 10-week line during its winning run last year.

A huge third-quarter earnings surprise launched the stock above its 10-week line on Oct. 28, 2011. (1)  It also set up a four-week in a long cup base. The stock broke out on Nov. 30. (2) The 10-week and 40-week lines moved back into normal alignment the week after the (3) — meaning the 10-week should lead the 40-week. As Align climbed, it pulled back to support at its 10-week average and built bases along the way.

The stock briefly shook free of its 10-week moving average after its April 23 earnings release. But it dropped back to the line and began another base that would run through late June.

Align made small stabs below its 10-week line in firm trade as early as January 2012. Yet in most cases, the stock sprang off its lows and finished the week higher and above the line.

In July, it began to punch through the line in more serious volume. The stock recovered in huge trade (4), but the incursion was enough to warn investors to be alert. The final break below the 50-day line came on Oct. 17 (5) (see a daily chart) in heavy trade. Align dropped 20% the next day; by December it was 41% off its September high.