Earlier on I explained this correlation of moving average to psychological of market players to some of the forumers in CNA Market Talk forum. I think it is better for me to repost it here for the benefit of more readers. Besides, I also try to reorganize some wordings from the post. I bet a lot of readers were scratching their head when they read the post earlier.
There are a lot of message Moving Average can offers. For example, Oversell condition, Force selling, bullish/bearish etc. Today we are going to discuss about how to make analogy and interpret MA as Resistance/Support in term of market psychology.
200MA is moving average of prices of 200 trading days. It is easier to interpret as those who bought within 200 days ago. Those is a group not an individual, you can also interpret it as 'market'.
When the price was below certain MAs, MA line serves as resistance. In psychological sense in stock market, this MA line for example 200MA is average prices for the 'market'. So if the current price is below 200MA and you bought within this 200 days, you suffer losses.
So when the current price is approaching the MA line (resistance) which is the break even price for those who bought within 200 days ago, you who bought earlier tends to sell when price break even. That's the reason why resistance is there to break. Especially for larger/longer moving average span, the resistance will be greater. Why? This is because the longer you wait, the more eager you wanted to sell off at break even price and secondly, there are more 'players' involved for longer MA span.
For instance, 50MA is weaker than 100MA and 200MA is stronger than 100MA.
So how does volume affect them?
It is an undeniable fact that volume means support to that particular price which is something like 'acceptance' for the price. The bigger volume means a larger portion of the market is accepting this price is reasonable for this particular counter for that particular day/session. That's why the volume grows when we are near bottom when more and more people is accepting the price of a particular stock.
Breaking out resistance with high volume does gives us more confidence. Yet, we need to consider throw backs too. When a break out is weak, throw backs can happens and at the worst case is false break out.
When price break through resistance, it needs to sustain to confirm the break out. Until then you who is one of those who bought within this 200 days start to become bullish (greedy). When the break out is more convincing, more 'players' will be joining in the boat.
MA as support is something opposite from what I mentioned above. Do you still need explanation? I guess I leave it for you to interpret yourself.
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Side notes:
Many TA practitioners used tons of special indicators in doing analysis. I am not saying that those indicators are useless but a lot of amateurs believe they are holy grail, magic black box that can produces BUY/SELL call immediately. I asked a lot of TA practitioners before, most of them don't even know what is the formula behind these indicators at all. Most of them analyse based on convergence and divergence theory.
Personally I still think that Price, Volume and Moving Average has a lot of message/clue for us and is one of the best indicators if we use them correctly.
The only problem is how to apply them because it is too subjective and could produces different results. I think the only way is to use them over and over again you got them mastered.
