Friday, August 14, 2009

Let's Play Ping Pong!!

It was only 5 short months ago, and prices on the major equity indices were below their simple 40 week moving averages. They were extremely below, and most were expecting some sort of snapback as the rubber band was stretched rather tightly. Well, the snapback has come and gone, and now we find prices on the other side of their 40 week moving averages, and oh by the way, we are entering extreme territory again (but on the other side of the 40 of course). The hot and cold market lives on as prices ping pong from one extreme to another.

The point here isn't so much to say, "Ah, prices are extreme and this is a top". Barring a market top, the extreme move from March, 2009 is indicative of two things: 1) the easy gains are behind us; and 2) the indices will likely move sideways to higher but in a more choppy fashion. If a market top comes out of this consolidation, it is likely to develop over the next several months. In general, market tops are affairs; market bottoms are events.

The S&P500 is now 15.39% above its simple 40 week moving average, and this is the highest value since April, 1999. Figures 1 through 5 are weekly graphs of the S&P500 going back to 1970, and the indicator in the bottom panel looks at the current price relative to the simple 40 week moving average. The black vertical lines highlight when price got more than 15% above the simple 40 week moving average, and this is would be when the indicator in the lower panel got above the maroon colored horizontal line .

Figure 1. S&P500/ 2002 to present

Figure 2. S&P500/ 1997 to 2001

Figure 3. S&P500/ 1986 to 1990

Figure 4. S&P500/ 1981 to 1985

Figure 5. S&P500/ 1971 to 1976

For the record the NASDAQ 100 (symbol: $NDX.X) is now 21% above its simple 40 week moving average, and this is the highest reading since September, 2003. The Russell 2000 (symbol: $RUT.X), prior to today, was 20% above its simple 40 week moving average, and this is the highest value since January, 2004.


Guy M. Lerner said...

A reader wanted to know what I meant by " In general, market tops are affairs; market bottoms are events."

It is my belief that market tops occur over time; they tend to be drawn out; there is a bullish v. bearish discourse; it is an affair.

Market bottoms are an event as in "bam" one day the market went down and then exploded upward; generally there is less discourse and more raw emotion

I hope that explains it

Anonymous said...

at some point you were writing a lot about stocks crossing 10 month average and how it would change your stance. I did not look at the graphs but i am pretty sure we crossed 10 month av. Would you please have another posting about this and explain why you are still bearish?

Guy M. Lerner said...

Anonymous: I will answer your question.

Since March, 2009 I have considered the rally a bear market rally for various reasons but most primarily that this was not the launching pad for a new bull market; going back 90's years on the Dow or 50 years on the S&P500, the technical characteristics seen at past bottoms were not seen at this one; so I still consider this a bear market rally, BUT I participated in that rally from early March to late April and early May. So in this instance I was bearish but bullish for the time I was long and in the markets.

With regards to the 10 month MA, my point was that just in case I got it wrong -that my methodology could not discern a new bull market -then a monthly close over the 10 month moving average on the SP500 would be a reasonable way to participate in any upside. I stated it many times that a close over the 10 month MA was arbitrary and not indicative of a bull market; the system was just a methodology to participate in the market; plus I had known risk -i.e., a close back below the 10 m MA.

I did some research combining my inflation indicators and the simple 10 month moving average system, and essentially I was able to improve the efficiency of the simple 10 month MA system by 50%; in other words, the new and improved system made more money with less draw down and time in the market.

The original MA system gave a signal at the end of June but inflation pressures were high; so I opted not to take that signal and I explained my reasons in an article on the site; this looked like a good idea because over the next 2 weeks the SP500 was down about 7% and trading at the 876 level; I then wrote a piece --which I published late -about utilizing utilizing the trading system as a tool to enter the market; that piece was published during the day that the SP500 started on its 2 week run to new highs.

At the end of July, inflation pressures had subsided, and the new and improved system --10 month MA plus filter for inflation pressures - triggered a buy signal. I also wrote about this in an article, and I put a lot belief in this particular system because to me it is very simple and it makes sense -- you don't buy the market when trends in Treasury yields, gold, and oil are strong.

But we have a signal and the market was rather stretched, and as stated in the article it is my intention to take a risk adjusted entry.

What do I mean by "risk adjusted entry"? Let me give you an example. Look at the charts in the current article and note when prices get this far stretched from the 40 week moving average prices tend to flatten out and either the price drops to the 40 wk MA or the MA catches up with price; let's say I would rather take an entry closer to the MA than 15% above it--this is risk adjusted.

Reading the current article, I am not sure why you think I am being bearish; I specifically stated that the extreme price move is not a reason to run for the exits; it may end up being that way after a period of consolidation but looking at the charts in this article there appears to be an upward, choppy push once prices got this far above the simple 40 week moving average.

There is no rush here; I don't view this as a time where I am going to get a fat pitch; for me that pitch was back in March; this may change in a couple days however.