April 4th, 2008

Are the Moving Averages Signalling a Bottom?

I confess, the market looks tempting. But it’s just at times like these that every investor needs a tool to help regulate their emotions. The biggest up-move since 1938 on the first day of trading in the second quarter, the index breaking above the 60-day moving average …. what else do you need to jump back in with both feet. This proves that the market has hit bottom and is now turning. Or does it?

Well, no, not really! Step back from the hour-by-hour, day-to-day trading and look at the terrain from 30,000 feet to see what’s really happening. Even better yet, what’s happened in the past under similar circumstances.

First, a chart:

True, the Index itself has crossed above the 60-day moving average and is now below the next 90-day MA (in MTI terms, a 17284, or 4321 [MA ranking] x 4 [Index position]). Over the past 44 years, what has been the market’s experience in that position and moving out of it?

  • has occurred 60 times.
  • Index has averaged 3.3 trading days in that position.
  • Average change during those 60 runs was a mere 0.6%.
  • 25 times, or 41%, the Index has dropped back below the 60-day and
  • 33 times, or 55%, the Index has moved on to rise above the next higher 90-day moving average.
  • The longest run of trading days in this configuration was 20 days in 1970 resulting in a 0.25% gain; the second longest was 14 days in 1990 with a 2.86% gain.
  • The market has been in this configuration for 3 days, since Monday’s 3.8% jump. Up to today, the current run is equal to or greater than 66%; only a third have been longer.
  • The gain is 4% so far, or slightly more than the average.

I should point out that if the Index successfully also cross back above the 90-day moving average, my back testing indicates continuing an “all cash” position. The reason is because over the past 44 years, there have been enough cases when such recovery moves failed and the market either stalled or resumed it’s decline.

Note, in the above chart, the nearly 55 point, or 3.9%, gap between the current 90- and 180-day moving averages. There’s plenty of time and room for adverse events to squash nascent bull market momentum. In other words, even at 1400-1420 on the Index, the risks outweigh the profit opportunities.

Should a crossover of the 90-day moving average take place within the next week or so, the more daring might want to take some small positions being fully aware and alert to the possibility that those position might turn out to be merely short-term trades.

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