Active Trader: All About Moving Averages

It’s the question on the minds of nearly every trader: Where do we go from here? With the market up nearly 60% from its March lows, many investors fret stocks have come too far, too fast. Professional investors are turning to technical analysis – the study of price and volume movements – for clues, and right now, two indicators are coming up with unusual readings, most of which haven’t been seen in decades.

The first indicator is the Standard & Poor’s 200-day moving average, the mean of the index’s closing prices over the past 200 days. Last week, the S&P 500 closed more than 20% above its 200-day moving average for the first time since Michael Jackson’s “Beat It” topped the pop charts, in May 1983. This came just six months after the index traded the furthest below its 200-day moving average since the Great Depression, according to Bespoke Investment Group, a money management and financial research firm. “It’s been a crazy market with a lot of mood swings,” says Justin Walters, co-founder of Bespoke Investment Group. “Things can change on a dime.”

History shows that the type of volatility the markets have seen this year isn’t good news for investors, at least in the short term. There have only been three other times when the S&P closed 20% below and 20% above its 200-day average within less than a year: 1932, 1938 and 1974. In all three instances, the S&P was lower one, three and six months after it went 20% above its moving average. However, in two of those cases, the market was up a year later, by 30.5% in 1933 and by 12.2% in 1975. It was down just 2.8% in 1939, Walters says.

Another unusual technical indicator, the “Golden Cross,” also suggests the market might move higher. This term refers to when the 50-day average moves above the 200-day average. In the past 30 years, there have been 14 Golden Crosses, with the most recent on June 23, says C.J. MacDonald, the portfolio manager of the Timothy Small-Cap Value Fund. In 13 of the past 14 times, the market has moved an average of 25% higher after the Golden Cross appears, MacDonald says.

How should investors position their portfolios for a choppy market? Those who think the market is in short-term correction can set tighter stop-loss orders, of around 5%, on their stock positions, Walters suggests. Also, this might be a time to take some profits and reset portfolios to their original asset allocations. On the opposite end, conservative investors like retirees could consider lightening up on stocks when the market closes below its moving average, says Keith Goddard, co-manager of the Capital Advisors Growth Fund. But most investors shouldn’t give up on stocks longer term, MacDonald says: “Trends tend to persist.”