REVIEW OF MOVING AVERAGE SIGNALS -- INTERMEDIATE SELL SIGNAL IS STILL INTACT -- BUT NO MAJOR SELL SIGNAL YET -- DOWNSIDE TARGET IF ONE DOES OCCUR

S&P RETESTS 200-DAY AVERAGE ... This is as good a time as any to take another look at a variety of moving average lines and signals. I'm going to show three different ways to do that. The first is the usual 50- and 200-day moving averages. The S&P 500 (and most major market indexes) have been trying unsuccessfully to break through their (blue) 50-day lines in decisive fashion. Chart 1 shows the S&P trading back below that intermediate-term resistance line in today's trading and putting the (red) 200-day average in jeopardy as well. The 200-day average is the more important of the two lines. Technical analysts use the 200-day line to help determine if a bull market is turning into a bear. Not every move below the 200-day average turns into a bear. But every bear market starts with a close below the 200 day line. That's why a decisive close below that line (especially a Friday close) increases the odds for a bear market. An even more negative signal is given when the 50-day average falls below the 200-day.

Chart 1

MOVING AVERAGE CROSSOVERS ... Another way to look for major market signals is with moving average crossovers. A signal occurs when the shorter average crosses above or below the longer average. Chart 2 covers the last eighteen months. Notice that the S&P dropped below its 200-day average in the spring and autumn of 2005 before turning back up again. In both of those cases, however, the blue 50-day line stayed above the red 200-day line. That prevented a moving average crossover sell signal. The same thing has happened this summer. A market drop below the 200-day line is a warning signal of a possible bear. That signal gets even more serious if and when the 50-day line crosses below the 200-day line. That hasn't happened yet. But the two moving average lines are getting dangerously close.

Chart 2

WEEKLY MOIVNG AVERAGE CROSSOVER SYSTEM ... One of our readers asked me to review a weekly moving average system that I wrote about last October 28. It's a moving average crossover system that uses the 13- and 34- week exponential moving averages. That combination has a pretty impressive track record as shown on Chart 3. The shorter blue line is the 13-week EMA, while the slower red line is the 34-week EMA. Major signals are given when the two lines cross. A glance at the last ten years shows what a good job it's done during that period of time. The system turned bullish at the start of 1995 and captured the subsequent five year bull market that ended in 2000 -- with one minor exception. A false sell signal was given in October 1998 (red circle). That false signal, however, was corrected with an upside crossing a month later. A major sell signal was given near the end of 2000 (red arrow) and lasted until the spring of 2003. A buy signal was given in the spring of 2003 (blue arrow) that's been in effect since then. Chart 4 compares the two lines over the last two and a half years. Although the lines converged three times during that time (see blue arrows), no downside crossovers occurred. That's a hallmark of a good trading system. Which brings us to the present. The two lines are converging once again. So far, no major sell signal has been given on the S&P 500. The only major market index that's given a bearish crossing has been the Nasdaq market. But the signals for that index haven't been as reliable as the S&P 500. Given the stellar record of the 13- and 34-week EMA crossover system on the S&P 500, it's worth keeping a close eye on.

Chart 3

Chart 4

COMBINING TIME DIMENSIONS ... Chart 5 shows two other other moving averages that I find useful. The blue line is a 100-day simple moving average; the red line is 400 days. I arrive at these numbers by studying weekly and monthly Bollinger bands. In bull markets, 20-period moving averages act as important support levels. Once a line is broken, it becomes a resistance line. I arrive at the 100-day average by converting the 20-week line into days (20 weeks equal 100 trading days]. The 400-day line is arrived at by converting 20-months into days. The breaking of the 100-day line is an intermediate sell signal. That took place during May. To negate that sell signal, the S&P 500 has to cross back over the blue line. So far it hasn't done so. A drop below the red 400-day (20 month) line is a major sell signal. That hasn't happened in three years. The red line has acted as support three times in the last two years (see red arrows). Right now, the market is trading between those two lines and remains on an intermediate sell signal. As of today, a close over 1288 is needed to give an intermediate buy signal. A close below 1231 would give a major sell signal.

Chart 5

MONTHLY BOLLINGER BANDS ... Chart 6 shows why the 20-month (400-day) moving average is so important. It's the dashed line in between the two solid lines which are monthly Bollinger bands. [Bollinger bands are plotted two standard deviations above and below the 20-month average]. The dashed moving average (middle) line acted as major support during the uptrend from 1995 to 2000 and major resistance during the downtrend from 2000 to 2003. A downside break of that line in late 2000 was a major sell signal; an upside crossing in the spring of 2003 was a major buy signal. [A valid signal requires a "monthly" close above or below the line. Intra-month crossings are preliminary signals and less conclusive]. Notice also in Chart 6 that in bear markets (2000-2003), prices trade between the moving average and the "lower" band. In bull markets, prices trade between the moving average and the "upper" band. That's been the case since 2003. And that's why the 20-month (400-day) average is so important. A downside crossing turns the major trend down and signals a drop to the lower band. The lower band then helps determine a possible downside target (see blue arrow). The difference between the upper band the moving average line is approximately 6% for the S&P 500. If the moving average line is broken, a likely downside target to the lower band would be in the vicinity of 12% from the May peak. I think there's a good chance of that happening between now and October. The key will be whether or not the 400-day line is broken. And whether some of the bearish crossover signals discussed above kick in as expected.

Chart 6