May 6th, 2009

Breakout or Resistance: The 200-day MA in the Beholder’s Eyes

I’m so frightened. The S&P Index closed today at 919.53, nearly closing the gap between itself and its 180-day moving average which today ended at 922.90 (for you purists, the traditional 200-day MA is at 954.77). A mere 3 point increase, or 0.37%, and the light will change from yellow to green according to my Market Timing Indicator. If that happens, it’ll be the first time since almost exactly one year ago, on May 16, 2008, at the end of that Bear Trap Suckers’ Rally. It stayed green for only one day. The next previous time was December 26, 2007 when it first issued warning of dire events to come by issuing an “all-cash” red signal.

Recent events are unfolding just as I had imagined they might. For example, on December 14, 2008 in “What Does 2009 Look Like From This Vantage Point“, I wrote:”

“I’m sticking with the game plan; it’s worked so far. We’re going to let the market tell us when it’s no longer in pain and is recovering. Back-testing through nearly 45 years of stock market history, I’ve determined that there’s little risk of “recidivism” when the S&P 500 Index (now at 879) crosses above its 180-day moving average (now at 1197).

I know it looks like quite a stretch but the market’s rapid descent beginning in August (38.71% between 8/11 to 11/21) is beginning to have a more pronounced impact on the moving averages and accelerating their convergence with the index itself someplace around 975-1000 sometime in March-May (in the absence of another leg down for the market). However, if the retest of the lows fails and the market declines further, below 752.44, then waiting for that confirmation signal will have paid off.”

It’s been an interesting journey since December and we’re finally arriving at the convergence, the crossroads. Moving Averages (MA’s) present clearer pictures of the general trend of time series of values than the series themself by smoothing out shorter term fluctuations.

Last night, I attended a NY Investors Group meeting where it was pointed out that while the NASDAQ Composite had crossed above its 200-day MA, each of the S&P 500, DJ-30 and the Russell 2000 had not yet crossed but were quickly approaching their 200-day MA’s. The information was given with a warning, however, that due to the negative economic and financial backdrop, the 200-MA’s would serve in this case as an insurmountable resistance; the market would reverse direction and continue back down.

[As an aside, those in the metro-NY should check out the group. Daryl Montgomery, its leader, always has interesting guests and usually offers his views on recent news important to the market and his assessment of current state of the market. Last night, he interviewed William Cohan, author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street”.]

The implication was striking in its unequivocal categorization of the 200-day MA as resistance, an impediment and obstacle to the market’s continued progress to health. It was in stark contrast to my measured anticipation over the previous 6 months of a slow convergence between the Index and its 200-day MA. I eagerly anticipated what I believed would be an eventual cross over.

When it does happen, my discipline will say its o.k. to jump in with both feet. My strategy, however, will be to remain mildly cautious and go in the water only waist deep (up to about 60% invested). There could be one last hurdle to cross, a neckline at around 950 of what could turn out to be an inverse head-and-shoulder pattern. But first, we may need to suffer through the formation of the right-shoulder, similar to the formation on the left:

If the pro’s can’t predict the future, I surely can’t. But I see this process possibly taking the summer (remember “sell in May and go away”) with the break above the neckline coming around Labor Day. In the interim, be prepared for the market to correct by 13% to the 800-850 area.

Once these milestone are achieved, the confirmation will be received that the market had turned, bulls will be in control of momentum and an true and rewarding uptrend will have been started. The market will have turned from its Accumulation to its Mark-up Phase and we will have survived a once-in-a-lifetime (we hope) Bear Market of collosal proportions.

Subscribe below or click here to learn more about help for navigating turbulent markets.