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Here’s the Actual Trend You Want to Befriend

Chris JohnsonOver my decades in the business, I’ve heard all the negatives and disbeliefs about technical analysis.

In general, investors fail to believe that this valuable tool will help them generate returns that beat not only the market, but also a lot of the Wall Street analysts.

Bottom line is that ignoring the technicals not only misses precious opportunities, but can also cost you lucrative returns, especially in a market like this one.

Despite all the doubts, even the most elementary investors are using technical analysis when they murmur the phrase “the trend is your friend.” Furthermore, they’re applying it to their investment approach when buying or holding stocks that trend higher.

Of course, as a true technical analyst, I need to quantify the term, not just say it to make myself feel good.

That said, the most widely watched – and somewhat accepted – technical indicator out there is the 50-day moving average. This, folks… is the trend that you should consider your friend.

Right now, the S&P 500 is fooling around with ticking off its friend.

Things Are Changing Rapidly Right Now

After spending 68 days above its 50-day and really maintaining a healthy trend since May, the S&P 500 is breaking below this key trendline today.

For the last four days, we’ve seen buyers come into the market to support the market as the SPX teetered on its 50-day (currently at 2,880).  The attempt to support the market at 2,880 indicates how well watched and important the 50-day is to traders.

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spx graph

 

Today, the fast and decisive move lower is sending a shock wave of selling through the market.  Of course, the big question is, will the selling continue?

Looking at history, there is reason to hold a positive view, for now. Let’s take a more detailed look at all this…

This Arsenal of Indicators Shows It’s “Game On” for the Bears

Since 1990, there have been 265 days where the S&P 500 broke below its 50-day moving average. Believe it or not, the performance of the S&P 500 is relatively positive after these initial breaks.

The table below details the slightly bullish bias as stocks average performance of 0.6% a month after these “breaks.”

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You’ll also notice that the average performance for these “breaks” is just slightly lower than the S&P 500’s performance since 1990.  In other words, the break below the 50-day isn’t a sign to sell everything, yet…

 

S&P 500 Returns

 

So, given the relatively bullish prediction of the historical performance, you shouldn’t worry, right?

Eh, maybe not.

Another valuable indicator in my arsenal monitors the percent of companies in the S&P 500 that are trading above their respective 50-day trend lines.

The chart below displays the percentage of companies in the SPX that are trading above their reactive 50-day trend lines. We’ve just dropped below 50% for the first time since July.

In general, a “dip” below this threshold is fine and will allow the “trend” to remain our friend, but there’s another outcome that’s not as pleasant.

An extension of this decline (in the percent of companies trading above their 50-day) will tell us that it’s “game on” for the bears as sellers will take control of the daily activity, increasing the long-term risk/reward profile of the market.

This is the other number I’m watching closely…

S&P 500 50 DAY CHART

So, here’s what to do:

  1. Hold your cards for the next few days. The S&P 500 index has a history of moving right back above its 50-day after these fast breaks below it.
  2. Look at the “Best in Breed” sectors like Healthcare (XLV) for opportunities to buy the dips on their respective 50-day moving averages.
  3. Maintain a vigil eye on the CBOE Volatility Index ($VIX) for the next buying signal. I’ll be back to cover this in more detail tomorrow.

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The post Here’s the Actual Trend You Want to Befriend appeared first on Money Morning – We Make Investing Profitable.

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