Good morning, wealth warriors!

Have you ever bought a stock after it spiked—or sold one after a sudden drop—wondering if you were too late or too early?

Even if you haven’t yet, chances are you’ll face one of two questions at some point:

• Do I jump in on the upward momentum?

• Or do I cut my losses before it drops further?

While there’s no perfect answer, research has uncovered a simple indicator that can help guide these decisions.

Of course, a well-diversified portfolio usually minimizes the need to make these calls. But sometimes positions get concentrated—like company stock—or you want to take a bet on something with high potential upside (and risk!). In those cases, the method below can add a useful tool to your investing quiver.

📽️ If you prefer to watch instead of read, I’ve also covered this topic in a short YouTube video—check it out here.

Happy weekend everybody!

Daniel

FINANCIAL TOOL
Short-Term Moving Average Distance (SMAD)

If you’ve ever opened your brokerage app after a big market swing, you know the feeling.

A stock that was up 10% last week suddenly looks like the next Google or Meta — you want in before it’s “too late.”

Or, after a quick drop, you feel the itch to sell before things get worse.

These gut reactions are natural, but they can quietly drain wealth from even the smartest investors.

Why? Because of a mental shortcut we all share called recency bias. And now, thanks to a group of researchers*, we have new evidence showing how this bias plays out in stock prices — and how to recognize when the crowd is likely overreacting.

*Ko, K. C., Wang, Y., & Yang, N. T. (2025). Short-Term Moving Average Distance and the Cross-Section of Stock Returns. Financial Analysts Journal, 1–21. https://doi.org/10.1080/0015198X.2025.2533099

Recency Bias and the Belief-Adjustment Model

Recency bias is simple: when we update our beliefs, we give too much weight to recent events and too little weight to the bigger picture. If a stock has been rising for a few days, we instinctively expect it to keep rising. If it’s been falling, we imagine the slide will continue.

Psychologists Hogarth and Einhorn formalized this idea in the belief-adjustment model: people anchor on their current view, then adjust it incrementally as new information comes in — but not always rationally.

We tend to anchor our beliefs, and even if something dramatically contradicts those beliefs, we will only incrementally change the belief. We take baby steps in changing our beliefs, if we change them at all.

But when we do alter our beliefs, it tends to be based upon the newest information—not because it’s the most accurate or the most important, but because it’s new. The newest information feels the most important, even if it isn’t.

Applied to investing, that means short-term price swings often feel more “real” and meaningful than long-term fundamentals. Which is exactly where the trouble starts — and the opportunity arises.

Technical Analysis, Done Right

If you’ve ever seen traders drawing lines on charts, that’s technical analysis — using past price patterns to forecast future moves. Most traders use it casually, often without asking whether the patterns really work or whether they’re just fooling themselves. And the overwhelming majority of technical traders lose over time.

Serious researchers, though, put technical rules through the academic wringer:

• They test signals across decades of data.

• They check whether results still hold after controlling for other known effects (momentum, size, value, etc.).

• They ask whether a rule still works in good times, bad times, high sentiment, and low sentiment.

• They apply their theory to out-of-sample data closer to the present day and confirm whether it appears to have predictive power (and isn’t simply a result of data mining — finding patterns that formed randomly but have no cause-effect relationship).

That’s the hard work of separating real effects from random noise. Most trading signals don’t survive this kind of scrutiny. When one does, it’s worth paying attention.

A New Signal: Short-Term Moving Average Distance (SMAD)

Here’s where the new research comes in. The authors of the research (Ko, Wang and Yang) invented a simple indicator they call the Short-Term Moving Average Distance (SMAD).

It works like this:

• Take the stock’s end-of-month closing price.

• Divide it by the stock’s 10-day moving average (the average price over the last 10 trading days).

• That ratio is the SMAD.

If the stock’s price is way above its recent 10-day average, SMAD is high. If it’s well below, SMAD is low.

You can put ‘way above’ or ‘well below’ into context by comparing the stock’s most recent end-of-month SMAD to its values over the past year. If today’s end-of-month SMAD is outside its typical range, it indicates that the recent price movement is unusually large relative to recent history — which, historically, has often preceded a short-term reversal.

Why does this matter?

Because when prices are far from their recent moving average, they grab investor attention. A sharp surge feels like a rocket launch. A steep drop feels like a crash. That perceived return potential tempts investors to chase a stock or to bail from one, often creating short-term mispricing.

The researchers found that:

• High SMAD (price way above average) often preceded poor performance of the stock in the near future.

• Low SMAD (price way below average) often preceded strong performance of the stock in the near future.

In other words, SMAD helps identify situations where the crowd is overreacting to recent moves — and where reversals are likely within the days and weeks ahead.

Why This Matters for Everyday Investors

You might be thinking: “That’s great for hedge funds, but I’m not trading daily.” Fair point.

SMAD is not about predicting the next decade — it’s about spotting short-term extremes. Still, that’s valuable for long-term investors in three ways:

1. Choosing Entry Points
   If you’re about to buy into a stock, SMAD can help you avoid getting swept up in hype. A very high SMAD is often a sign you’re buying after an overreaction, just before a pullback. Waiting for prices to cool off could improve your odds.

2. Recognizing Panic vs. Longer-Term Downtrends
   When markets dip, it’s easy to assume disaster. But if SMAD shows prices have sunk well below their recent average, that’s often a sign of overreaction on the downside. Instead of panicking, you might recognize a correction that’s likely to mean-revert (return to its longer-term average).

3. Avoiding Emotional Traps
   Historically, many of the market’s strongest rebound days occur close to its steepest declines. That’s why panic-selling often locks in losses right before the rebound. By reminding yourself of measures like SMAD, you anchor decisions in data, not just gut reactions.

Put simply: SMAD doesn’t tell you what to hold for 20 years, but it can help you keep cool when everyone else may simply be overheating.

Stocks vs Indexes

While this mispricing effect has been demonstrated in individual stocks, it has not been tested thoroughly at the index-wide level (such as with the S&P 500).

This makes sense conceptually, since an index tends to smooth out the sentiment extremes that occur more sharply in single names. The strength of the phenomenon lies in capturing exaggerated swings in investor sentiment, which can be muted once many securities are aggregated together.

This method also excludes micro-cap and penny stocks, which were not tested.

For investors holding concentrated positions in company stock, however, this measure can be particularly useful. It provides a quantitative way to gauge whether recent price action reflects an extreme level of pessimism (a potential time to hold or even accumulate) or excessive optimism (a potential time to reduce exposure).

In practice, this could help someone decide when to diversify out of their company shares—avoiding a sale during an unusually negative slump, or conversely, using a period of elevated sentiment as an opportunity to trim at stronger prices.

The Bigger Picture

At the end of the day, no single signal is a magic formula. But research like this matters because it gives us a scientific lens on investor behavior. Recency bias isn’t just a psychological curiosity; it leaves fingerprints in the data. By testing a simple ratio of price to 10-day average, the authors reveal that those fingerprints can be detected, measured, and — potentially — used to an investor’s advantage.

The takeaway isn’t that you should rush to trade SMAD signals tomorrow. Rather, it’s that our instincts are often backward-looking, and recognizing that can save you from costly mistakes.

In Summary

Think back to that moment of staring at your brokerage app after a big swing. The temptation to chase or to flee is powerful. But what feels most urgent — those recent moves — is often the least reliable guide to what comes next.

The research on SMAD is a reminder that discipline beats chasing heat. By stepping back, questioning the pull of recency, and grounding decisions in tested insights, you set yourself apart from the crowd.

And in the long run, avoiding costly mistakes gives tremendous advantage in building wealth that lasts.

Daniel Lancaster, CFA

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