Perhaps the most widely followed indicator coming out of Technical Analysis is the simple (non-exponential) 200 day moving average (MA). Even “pure” fundamental analysis orientated Portfolio Managers who dismiss the charts often follow the 200 day MA. Interestingly, there are less and less of those guys around these days (!). The chart below is a monthly bar chart of the S&P500 with a 10-bar MA overlay. Ten months is roughly 200 day of trading, so the indicators are close.
As you can see, the 200 day MA (10-month) did a fine job of keeping us in the market during the good times, and getting us out in the bad times. I always follow a rule of 3 bars on a weekly chart to verify a big signal –so the approximate equivalent of a 1- bar move through the 10-month MA should be ignored. Wait for a second month below the average before selling. As you will see, the MA whipsawed us only three times over the past 25 years. I’ve circled these occurrences in 1998, 2010 and 2011.
I do not count the sideways market of 1994 as a time of false signals—as it was obviously a “Phase 1” trading range market, as indicated by my numerical indication on the chart . I have labelled each market phase numerically in the chart – as base or consolidation (1), uptrend (2), top (3) and downtrend (4). MA’s lose their effectiveness in sideways markets, and as traders we must be cognisant of basic trend identification before relying on other indicators (watching the highs and lows).
The red arrows on the chart show us the accurate buy and sell signals for the S&P500 since 1991. The big moves were most certainly identified during this period. Even if you had sold and bought back in on the false signals during the 3 circled movements on the chart, you would have still profited in following a buy/sell system off of the 10-month/ 200 day MA.
So where are we right now when looking at the 10-week MA? As you can see on the monthly chart, we’re still in bull market trend. That is, the S&P500 is above the 200 day MA. Of interest is the sideways market of late. Should this market continue to be choppy—it may turn out to be like 1994. We may get a couple of over/under buy sell signals. As noted, a moving average system is useless in a sideways market. The current market is definitively sideways- indicated by my horizontal lines on the weekly chart below.
As such, I haven’t waited for the 10-month MA to crack to raise more cash. We’re at 45% cash in our equity model right now. Sideways markets are better traded with momentum oscillators and volatility bands as noted in my recent blogs. If I do spend some of that cash (as I did recently – bringing my cash down to 45% from 50%) I will do so on my timing signals – as described here. I recommend reading my book Sideways to learn more about identifying which indicators to use & when – according to various phase and market conditions.