Last June I took a look at the S&P and studied the relationships between the 20-day, 50-day and 200-day MAs and the index. In June I concluded:
The take home lesson is for the next month or two further downside is not just likely but probable; only in 2003 did a rally develop soon after the match. For the other five of the six matches the S&P lost between 7% and 30% of its value before it finally turned around.
From a buyers perspective there is little incentive to be long S&P futures or stocks until a firm break of the 200-day MA occurs.
The good news for bulls is once the S&P gets past the 200-day MA there is likely to be a very tradable rally.
In October 2008 I followed up with
# We are likely a couple of weeks from a bottom, but it is not impossible for this to take longer
# During this period the market will see sharp losses, perhaps trimming 10-20% off where the markets lie now (Monday will be the start)
# The subsequent rally will be short lived and will morph into a retest of the low
# The retest will be the time to buy heavy
# A significant bull market has a good chance of emerging from the quagmire - remember markets lead economic news.
In November I talked about a potential "Obama bottom" and then concluded
The worst looks to be behind us but we won't really know until we see what happens when the 200-day MA comes into range; a solid cut through and it will be up and away; however, a negative response to the 200-day MA test could produce a 1932/2002 style scenario in 2009 bringing with it another big step lower. If there is a silver lining to the worst case scenario it's that the current picture suggests we have already reached the extremes of the 2002 capitulation and not the pseudo-capitulation generated after the September 11th attacks.
So where do we stand now?
On the 16th of September 2009 the S&P was 20% above its 200-day MA, 8% above its 50-day MA and 4% above its 20-day MA; the largest difference between the 200-day MA and the S&P in recent weeks.
Just to show how extended the market is, the largest difference on record (since 1950) occured on the 3rd November 1982 with a 23% extension from its 200-day MA. September 16th ranked 33rd out of 14,571 data points! Quite the reversal!
Going back into the time machine, the neon coloured eighties was littered with this MA set-up:
Which suggets the next few years could see a modest bullish turn (the next cyclical bull market?):
Even over the short term action tends to follow the wind and find support at the MAs, with one big exception:
Given the S&P's sharp move off of lows it would appear momentum is set to continue in favour of bulls as sideline money steps in on weakness. But look for this rate of ascent to slow as markets work off overbought conditions and MAs 'catch up' with the index.
The 50-day and 200-day MAs should provide support and buying opportunities for new long positions. Stops can be placed on a decisive break (>1%) of the 200-day MA, protecting against any 1987 like outcome. But even here, the losses of 1987 did little to erase the bulk of the gains the S&P had chalked up earlier during the decade.
Although pre-1950 was excluded from the dataset it would appear unlikely a major downleg will follow.
Could it be argued we're at a 1937 style top? If so we may see a very sharp sell off (a la 1987) - one which could see the indices lose half their value - but not one to violate March lows to any great degree (something Elliot Wave Theorists are looking for).
There is plenty of expectation for a major downturn but this expectation may yet be to early. A major downturn is inevitable at some point of the future, but when it occurs markets might have long since sailed higher.
The trend is certainly your friend here...
How can this work for you? Track your interests using Zignals Stock Alerts; set alerts to trigger at 50-day and 200-day MAs, or approaches to these MAs (if thinking of buying).
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Dr. Declan Fallon, Senior Market Technician, Zignals.com the free stock alerts, market alerts, stock charts, stock screener and stock portfolio manager website