Hi Phil Town,
I have a simple question. The software I am using lets you set the moving average based on the opening price or the closing price or the high or the low for the day. Which one do I select?
Peggy's investing software for Tools gives her four choices for price input to the Tools from the market. The high price, low price, opening price or closing price. So if you have a similar choice, which one should we choose?
The simple answer is usually best: choose the closing price.
The reason is that the research done on almost all of these tools by their original developers used closing prices as the input for price. And that is not just arbitrary. Options traders will tell you that 2:30 in the afternoon is when the real action starts. Between then and the closing bell things can really change. That's because many day traders and options traders do not want to hold a highly leveraged position overnight. There are too many examples of bad news coming out of nowhere after the closing bell. That means the closing price is often the closest price to what the market thinks about that stock on that day.
You can really see this at work on the first days of an IPO -- Initial Public Offering. Before the first day of trading in a new stock, the investment bankers take the corporation's management team on a tour of brokerage houses across the US to have the managers tell their business story and to let the brokers ask questions. This is called the "Dog and Pony Show" because it takes on a certain show-ring air.
After the dog and pony show is over (usually about a week) the investment bankers call around and get a sense of what the investors out there are telling their brokers about whether they want to buy the stock on the opening day and at what price. The trick for investment bankers is to set the price high enough that the company owners feel they didn't sell it too cheap and low enough that the stock will go up after it goes public to please the new investors. They set the stock price right before the first day and hope they got it right.
After the opening bell, their brokers sell to the investors who expressed a desire to buy in the prior weeks. Those sales are the opening price. As the day goes along, the investment bankers (and the opening bell investors) hope and pray that there was a backlog of investors who couldn't get shares at the opening who still want shares at that price. If there are lots of them, the price will move up as demand exceeds the supply of sellers. But by the end of the day, the price may return to the opening price or even go below it, depending on how the public thinks about the future of this company relative to its price.
For most experienced investors, the opening price is going to reflect a lot of hype from the day before, while the closing price, theoretically, is a sober reflection of reality. Or so they say.
The reality is, of course, always changing. Still, we have to use something consistent, and so we use the closing price for the input into these tools.
Now go play.