Money: Following the Moving Averages

When will it be time to buy more gold or silver? At what price should one sell (go short) gold and silver? When should one buy into the next bull market in hard currencies?

These are perennial questions and apply to all kinds of investments. A bimonthly column cannot hope to answer them for you. Fundamental analysis can provide some good notions for medium- to long-term investment decisions. But even close attention to the fundamentals cannot tell you with a high degree of dependability at what price to buy or to sell.

True, someone who closely follows the price action of a stock or commodity (with or without reference to charts) and who stays informed about shifting supply and demand factors can make some educated guesses. He can buy on retrenchments and sell at or near a previous peak. And if he acts consistently he can generally make money. But that approach would not have availed the average trader much in the recent gold and silver eruptions. There was simply no way to predict that untoward political events would carry gold above $800 and silver above $40. Most would have liquidated their positions at much lower levels or, worse, taken up open short positions at those lower levels—and gotten burnt.

There is no absolutely sure-fire way to make money and avoid losses. But there is one proven method by which to minimize losses while maximizing gains—a technique for actualizing the old axiom "Cut losses short and let profits run."

It's called the "moving average system," and it has brought its practitioners into the market at propitious moments, kept them in for near the duration of major movements, and then told them when to exit. It sounds too good to be true, especially to proud fundamentalists, who are wary of being wholly wedded to the austere mechanics of charting.

But let's be open-minded. First, what exactly is the moving average system? It is simply a scheme of plotting averages of closing prices for various periods and superimposing them over a standard bar chart (showing each day's high, low, and closing prices). Typically, 4-day, 9-day and 18-day averages are used in conjunction. What results is a set of three trend lines following (with a lag) the movement of the bar chart's daily price action. The theory is that when the shorter-term average intersects with the long-term averages, a buy or sell order is indicated (depending on whether the trend is up or down). The system is designed to signal trend changes far enough in advance for the investor to take advantage of most of a bull or bear move).

A leading exponent of the moving average system is Dr. Wray A. Kunkle, a vice-president with Wheat First Securities in Washington, who says that the theory worked effectively in making good profits for his clients in both gold and silver during their recent run-ups, while preventing them from being caught short. Kunkle said the beauty of the system is that, "through daily homework, a trend change can be spotted early enough to participate in a run. It is not necessary to monitor daily news events or to analyze statistics, political manipulations or other fundamental factors that actually affect the markets." Kunkle says that he does not totally eschew such fundamentals but emphasizes that the system's track record has proven it to be a more reliable approach to trading. "For gold, this system has been amazingly accurate," avers Kunkle.

When asked recently whether he foresaw an imminent surge in the Deutschmark and Swiss franc, Kunkle replied that it is inevitable at some point. He predicted that, at some point, central bankers will "run out of money to support the dollar with.…They can't hold back the tide of big money moving out of the dollar." Kunkle is not alone in that feeling; New York adviser James Sinclair recently predicted the Swiss franc would reach one-to-one parity with the dollar sometime in 1980 (it's now worth about 64 cents). Ah, but when? Asked if now is the time to buy marks and francs, or failing that, at what price one should buy, Kunkle issued a predictable, but uncannily reliable response. He uses it in answer to all such questions: "Just follow that system."

Without reference to charts it is difficult to give the reader a full grasp of how the moving average system works. Those who are interested should get access to the weekly Commodity Trend Service (100 E. Kimberly, Davenport, IA 52806; 319/386-2950). Any broker worth his salt probably subscribes. You may wish to subscribe yourself at $300 per year and update it daily. Or, if you like to chart and make your own trading decisions, plot your own.

It's a simple matter. Get the daily closes for your favorite commodities (or stocks) from any good daily newspaper and plot them religiously on graph paper. Then, begin computing the three averages mentioned above. For the 4-day average, just add the last four days' closing prices and divide by four. For the 9-day and 18-day averages, do likewise with the closings for those respective periods. This kind of procedure can easily be programmed on a home computer, to minimize the drudgery.

"When the 4-day moving average penetrates (intersects) the 9-day moving average," explains Kunkle, "this signals a change in the trend. More conservative traders may wish to wait for the 4- and 18-day averages to intersect. When looking for sell signals, the rules are often a bit different, he advises. Because volatile markets often fall faster than they rise, it is not always wise to wait for the 18-day average to cross the 4-day in order to confirm the previous 9-day intersection. Sometimes, he says, it may even be prudent to act when the 9-day average intersects the current price.

As much confidence as he has in the moving average system, Kunkle is careful to use stop loss orders. These are instructions to one's broker to buy/sell above/below specified price levels in order to liquidate short/long positions when a reversal is in the making. He says "the system" can help in determining where to place these stops. Thus, with a long position, the cautious trader would move his stop-sell orders upward at a safe level below the average trend lines. With a short position, one would move stop-buys downward at a safe distance above the averages.

No system is perfect, but in the heat of a mid-January rally in the precious metals, Kunkle exulted that this one "is dynamite—right on the button in fact!"

Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.