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The 200 Day Moving Average Short-Term Trade

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The 200 day moving average (dma) is used by institutions when considering the purchase of a stock. Some firms will sell a stock once it closes below its 200-dma. Some long-term shorts will cover a stock once it trades above the 200-dma. A moving average is also most applicable to the major market averages. Finding patterns that correlate with a particular average and stocks has been easy recently.

For its part, the Nasdaq-100 (NDX) advanced past and closed above its 200-dma back on December 5. The day the NDX broke above its 200-dma it advanced substantially higher. The index opened slightly above its 200-dma, but proceeded to advance by about 70 points after the open. However, in the following weeks, the NDX slid back down its 200-dma, consolidating its gains. It traded back above the moving average last Thursday and again had a solid gain after the initial advance.

The pattern displayed by the NDX is cropping up all over in the tech sector. The first stocks to follow a similar pattern were the bigger caps in the technology space such as Yahoo (NASDAQ:YHOO) and Applied Materials (NASDAQ:AMAT). That much makes sense because the bigger, quality names in technology should be the first to breakout above resistance levels, in this case their 200-dmas. Notice the similarities between the NDX's breakout and the YHOO and AMAT moves below. Although the moves in YHOO and AMAT came at different times, the initial pops above their 200-dmas was very similar to the advance in the NDX.

Now, the smaller stocks in technology are displaying similar patterns. Aether Systems (NASDAQ:AETH), which is in the wireless space, is one stock that sticks out in my mind. Last Thursday, the stock traded past its 200-dma for the first time in about 16 months. The 200-dma was around $10 last Thursday, when AETH proceeded above it to close at about $10.65. It traded as high as $11 the next day, but pulled back in similar fashion to the other 200-dma breakout moves in the NDX, YHOO, and AMAT.

Granted, a $1 move isn't big and not necessarily conducive to options trading. But in percentage terms, a $1 move in a $10 stock is solid, especially for a day trader using the underlying as the medium with which to implement the position.

There may be more of these trades cropping up as the beaten down small cap stocks rise from the mire. Of the charts I've studied, the one- or two-day pops above the 200-dma work best in an advancing market. Obviously today is not that type of market. So, if you do implement this strategy, make sure to wait for the type of market that would support a rally.

These trades are very short-term in nature, preferably one day, but two days at most. Very short-term. You'll notice that as you study past breakouts that most tech stocks slide back down their 200-dmas for a period before resuming their rallies.

Eric Utley
Option Investor

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