Last week we wrote about the simplest indicator of market direction — the 200-day moving average. We talked a bit about what it is, how it is used and why it is one of the most reliable ways to estimate the direction of the market. It’s still not a crystal ball, but it is a very good tool.
Today we will continue that discussion and delve a little deeper into what can (and cannot) be learned with this device. As a reminder, when we talk about the market we are using the S&P 500 Index* because it represents the bulk of the invested dollars in the USA. We will again print the picture of the S&P Index that we showed you last week. This picture shows the past two years’ activity of the S&P Index with a dark – and quite volatile — line. That line shows the daily activity, including all of its associated drama. On the other hand, the red line shows the 200-day moving average. Both lines ultimately reveal what is essentially the same information but the dark line does it in a frenzied way and the red line shows a more studied interpretation. It’s relatively easy to note when the market is above the red line and that is the important thing — because this is when stocks tend to be stronger.
But several of you mentioned that sometimes the market moved back and forth above and below the red line, and wondered if those are not indicators of when to move in or out of the markets. Good question for sure, so let’s look at its implications.
Market technicians take our graph a step further by using a shorter moving average (typically the 50 day) and showing that along with the 200-day moving average. Here’s what that looks like: