Wednesday, August 31, 2011

Low Extremes in the S&P

As the market takes another step higher I took a quick look at S&P price low extremes relative to its 200-day MA. The data covers the period of 1950 to the present day, so it does leave out the 1929-1933 period. But the table does highlight the rarity of extreme sell offs.

Over a 60 year period there have been 10 years when the S&P was at least 15% or more away from its 200-day MA and only 4 years when it was 25% or more. The months, November 2008 and March 2009, when the S&P was trading more than 30% below its 200-day MA, are actually very rare events.

But the rarity of such events offers its own problem. If you were a buy-the-dip player and bought stocks when the S&P was 15% or more from its 200-day MA it would have been a tough call to have held those stocks as losses mounted in the latter part of 2008 and early 2009.

Even then, the 'average' frequency for a sell off greater than 15% from its 200-day MA is 1 year in 6. So if you bought at the 15% extension - then sold soon afterwards as losses continued - you could be waiting another 6 years for the next buying opportunity! However, one could be waiting even longer given the clustering behaviour of selloffs. There was a 13 year gap between 1974 to 1987 and 1988 to 2001.

The recent decline is interesting because it followed a lengthy range-bound (dull) period. The resulting fall garnered more attention because it was so hard and fast. As a result, it quickly extended itself from the slow moving 200-day MA, maxing at a loss of 13% from its 200-day MA on August 8th. While the S&P has recovered the bulk of this loss, the early August decline came very close to becoming one of those rare "15%+" events.

The S&P may yet take another turn lower, particularly when we enter the seasonally weak September/October period. But should it turn into (or get close to doing) a "15%+" decline event from its 200-day MA then it may yet prove to be one of the greatest buying opportunities for the next decade or more.

What will history show ten years from now?


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You can use a Zignals market alert to track 15% declines; the SPY 200-day MA sits at $127.79 which means a "15%+" decline event will occur on a Price Crosses Below $108.62 . Because the 200-day MA is a slow moving average it may only be necessary to update the Crosses Below value just once a week, updating the value daily when the current price gets close to the trigger price.

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