​Paying Above Average Prices?

Chuck Fulkerson  |

Let’s talk about being a smart consumer. I am a dad of two amazing little boys, and a few years ago now steeped deep into “dadhood” I knew it was time to step up from the sedan to the ever important SUV. This SUV purchase was an important one- one that would help to define my children’s early memories of road trips, baseball games, sleeping in the car, and all that comes with childhood. Clearly, this was an important purchase; so I did what most smart shoppers do before buying a car: research. Many people spend hours and hours researching the right model, and once that model has been chosen comes the difficult task of getting the best price. Luckily for car buyers of today, the internet simplifies this process by having many websites that will aggregate dealer data to give you a very accurate price you should reasonably expect to pay. Sites like TRUEcar.com (TRUE) (TRUE) among others will aggregate prices and give you a statistically relevant expectation of the average price in your area. Take a look at the car I selected below, a good reliable mid-sized SUV.

Thanks to TRUEcar, in just a few seconds I can very easily see that the market average for this car is $24,214. This is the number right in the middle of the bell curve of normal distribution. For just a moment I want you to put yourself in the shoes of a car buyer armed with this knowledge as you walk onto the lot. Walking onto the lot, looking to buy this car would you tell the salesperson that you know the average price for this car is $24,124 but you will only buy it for $25,500 or more? Of course you wouldn’t! If you are like most smart shoppers you are going to want to pay below average prices so that you can get a deal. This seems like such a simple concept but is not something we regularly do in our investing life.

Now let’s take this example to something I see retail traders and investors do on a regular basis, and that is: base investment decisions on price relative to a moving average. First, we have to understand what a moving average is. Look at the below chart:

Take notice of the blue line cutting across the price of U.S. Steel (X) (X). That blue line is the 50 period simple moving average. A simple moving average takes the average closing price of the last “X” number of periods and places it as a dot on the chart. When a new price is formed, the oldest member of the sample falls off and the newest one replaces the oldest, hence the moving part of a moving average. The moving average will continue to change, and the smaller the number the more volatile the average will be. Specifically the 50 period moving average is the one most often used as a “support” line. By a support line, I am referring to how traders use the 50 day moving average as a floor and only buy when price is above the average. Often times this strategy will get traders into strong trending environments, but more often than not they will be making buy decisions after the rally in price and often to a level where supply exceeds demand. Back to the example of buying the car, this is not what we would do in our everyday lives; we don’t want to pay above average prices for a car. So why do we want to pay above average prices for a stock?

A better way to think about buying and selling in the financial markets is the way we actually buy and sell other things in our lives. Investors need to think more like the Costco’s (COST) (COST) of the world by buying at wholesale and selling at retail. As investors, if you can find the wholesale price like institutions and professionals you can have a significant advantage over other retail traders and investors. The moving average has nothing to do with true wholesale and retail pricing, it is simply a measure of previous price movement. Look at the picture below:

Notice the yellow box as the origin of a rally in price. This rally in price existed, because there were more buy orders than sell orders in that range. Price was forced to rally from that area. That is an area that we know was a buying point for professionals in the past and will be again in the future. When price returns it is easy to see that it rallies off of the level. Traders waiting to buy after price crosses above the moving average would give up significant profits and will be late to the opportunity if they are waiting for the moving average. If you want to get results like the professional investors, just keep it simple, and buy stocks like you would buy anything else in life.

Chuck Fulkerson is the Director of Student Development at Online Trading Academy, a leader in investing and trading education for any market or asset class. Fulkerson helps education individuals across the globe in what it means to be a successful investor and trader. He currently trades options as a swing and position trader; futures and currencies as a day trader; and equities as an investor to round out a truly diversified trading portfolio.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
TRUE TrueCar Inc. 5.06 -0.11 -2.13 1,453,126 Trade
COST Costco Wholesale Corporation 280.17 -1.34 -0.48 1,459,550 Trade
X United States Steel Corporation 15.38 0.31 2.06 12,328,180 Trade

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