September 7th, 2010

Caught in the Vice of Moving Average Compression

I’ve been struggling for several days trying to come up with something new to write about, some new insights, some new strategies …. something. So far, everything seems to be moving along in line with expectations:

  • The market is cooperating in forming the right shoulder of the inverted head+shoulder pattern, what others now say is one of the most reliable reversal patterns.
  • I’ve been buying tech stocks and they all mostly seem to be leading the charge higher
  • Precious metals, whether gold, silver or miners, all are taking their time and aren’t, so far, succumbing to all the earlier chatter about it being a “crowded trade”.
  • Chinese stocks look like their picking up some new life even though others say that the Chinese economy is giving indications of slowing down as evidenced by news today that Chinese steel mills are shutting down for two weeks due to excess inventory and slow economic growth.

There just isn’t much more to say right now other than the possibility that this forward momentum may stall out for a couple of weeks. Some may attribute it to a market that’s “ahead of itself” or an “overbought market” or “overextended market”. For the rest of us who give more credence to the Lunar Cycle than to “talking heads” know that tomorrow will end the current phase on a successful note (more on that after the close tomorrow).

Or my writer’s block comes from the anxiety and apprehension that this complacency will soon start all falling apart. The moving averages are starting to compress and fall on top of each other.

My curiosity got the better part of me so I went back to the data to find prior occurrences of this degree of compression (defined as the variance between the highest moving average and lowest, in percentage terms) and found that out of a total 11960 trading days since March 12, 1963, there have been only 29 times encompassing 1396 trading days, or 12%, in which the moving averages were as compressed or more so than they are today. The average length of time before expanding out was 48 days; there are only 3 days so far so it could continue a while longer.

For the moving averages to become so compressed, there had to have been a long period of lateral movement similar to we’ve been experiencing. For each of the 50-, 100-, 200- and 300-dma’s to be no more than 3% apart means that the market index had to have been on average no more than 3% higher or lower than the current level. One wold expect that the odds favored a substantial trend movement, either up or down, after an extended lateral movement where the moving averages become compressed. However, the disappointing information from the analysis is that 60 days after the moving averages started diverging again, the range had increased on average only 0.8% and a miserly 1.6% 120 days after the last day of compression.

While we can hope that a break above the neckline will confirm the reversal but it could take well into next year for a break above the next price objectives of 1150-1164.

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  • Anonymous

    Joe,,you own any mining stocks now ?? I have RBY and VGGCF for takeover reasons..

  • Joe

    I do own quite a bit of DGP (the gold double long), SLV and my miner is IAG. I'm going to hold on to this as they continue making new highs.