April 25th, 2008

Critical Importance of a 180-day Moving Average Crossover

Why am I so convinced that a move above 1430 on the S&P 500 Index is so positive (or “constructive” as the talking heads on CNBC alway say for some reason or another …. I’m not sure I even know what it means or how it applies)? It’s because I’ve researched the data on what the market’s actual experience in identical situations over the past 45 years has been and here are the facts:

  • There have been only 15 occurrences when the four moving averages were aligned as they are now and the Index itself was between the 180- and 300-day moving averages (to where we hope it will next move as I previously wrote).
  • The Index moved up through the 180-day moving average every time except once, when it move down through the 300-day moving average.
  • The average change in the Index (excluding that one exception) was to move up 2.16%; in the one case where the Index came from above, it declined o.75%.
  • The Index spent only a total of 67 days (out of a total 11500 covering the 45 years) in this configuration and the average number of trading days before the Index experienced another cross over was 4.5. The longest was 19 days before the next cross over and the shortest was a single day.

Should we be so lucky that a cross over the 180-day in fact materializes, what can we expect after that? In the 15 previous occurrences which way did the market next move? Here the news isn’t quite as rosy:

  • In only a third of the occurrences was the Index able to follow up with a move above the 300-day moving average; in 66% of the occurrences, it reverted back below the 180-day average.
  • The longer it was above to stay above the 180-day moving average after its cross over, the more likely it was to continue moving up. A reversal of its recent cross over, if it did happen, took place within one and no more than 6 days later.
  • The next cross over, of the 300-day average, happened anywhere from 2 days to as much as 19 days later. The average gap between the 180-day and 300-day at the time the Index crossed up into this area was 3.65%, with the greatest being 7.5% which required 19 trading days to cross.

As of today, the gap between the 180-day and 300-day is a mere 1.4% so if this burst continues sufficiently to allow the Index to cross above the 180-day moving average then there’s a good chance that momentum will be sufficient to truly launch a new bull market phase.

I’ll let all the other talking heads and bloggers give you the explanations of why all this is going to happen. It’s the fact that the Fed will pause and hold rates at this level (that’s the first time I can remember a rate halt as being bullish!) which will stabilize the $US, help deflate the commodities and oil bubble, etc., etc. I’m going to rely more on the above facts and less on the subjective story. Here’s a chart so to help you visualize the above possibilities and challenges of this critical juncture:

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