As a stock price rises, it often pauses due to various factors, including profit-taking from prior gains.
During this process, the stock price undergoes a correction and approaches its Moving Averages (MA). In the short term, it may approach the 5-day MA, or in many cases, it may find support at the 20-day or even the longer-term 120-day MA.
If a rising stock approaches the 20-day MA, buying interest tends to increase, making it more likely that the stock will rise again near this level. In a bullish phase, each MA acts as a support level.
- This correction phase occurs when a stock pulls back to the 20-day MA and then rebounds. If the stock fails to find support at the 20-day MA and continues to fall, it is likely to extend its decline toward the 120-day MA.
In a bullish cycle, the stock price is supported by the MAs, rises, corrects, and then rises again, repeatedly forming an upward "N" shape.
In a bearish phase, however, each MA acts as resistance. When the stock price rises near a previous purchase price level, it triggers selling from investors looking to break even, leading to further declines.
During a downtrend, even if the price temporarily breaks above the 20-day MA, it often faces strong resistance near the 120-day MA.
- If the stock is below the MA, most participants are at a loss, so when it rises near the breakeven level (around the MA), short-term upward moves often end, and declines intensify. This scenario is commonly called a "rebound."
- Following these support and resistance principles, large holders often buy during corrective phases in an uptrend and sell during rebounds in a downtrend.
Squeeze and Divergence
MA Squeeze and Divergence
When the stock price rises, it naturally diverges from the 20-day MA. This signifies that buyers who entered within the past 20 days are seeing profits, prompting some to sell and take profits, which naturally pulls the price back toward the 20-day MA.
When MAs Squeeze at a single point, it is called "Squeeze." When they spread apart, it's called "divergence."
- In a bullish phase, buy when MAs Squeeze and then diverge; in a bearish phase, sell during divergence.
Cross Analysis
MA Cross Analysis
- Golden Cross = Buy Signal: The short-term MA crosses above the long-term MA (e.g., the 20-day MA crosses above the 120-day MA).
- Death Cross = Sell Signal: The short-term MA crosses below the long-term MA (e.g., the 20-day MA crosses below the 120-day MA).
If a long-term declining stock experiences a "dead cat bounce," the stock has already rebounded significantly, and profit-taking selling may emerge, creating a temporary correction (see chart above).
- After a "dead cat" rebound, a short-term decline is typical.
If a previously rising stock experiences a correction, it may appear attractive to investors who hesitated due to high prices. This may lead to buying pressure due to expectations of a renewed rise after a brief correction. Even if there is a short-term rise, rebounds during a downtrend can trigger selling from those seeking to break even, resulting in only slight gains. Over the long term, it is likely to continue declining.
- In practice, many times the price will drop sharply without a "dead cat bounce" (mainly because the bounce is typically driven by individual investors).
When the price declines quickly, buying pressure may arise with the hope of a rebound, but major holders may use this opportunity to sell off remaining shares.
After an MA cross, it is crucial to respond with buys and sells as appropriate. In particular, avoid being caught by "dead cat bounces" after resistance events.
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