A LOT OF MARKETS ARE MEETING RESISTANCE AT THEIR 50-DAY AVERAGES -- COMBINING SIMPLE AND EMA AVERAGES -- WHY 50-DAY LINES ARE LIKELY TO KEEP FALLING

RALLY STALLS AT 50-DAY LINES ... Two Tuesdays ago (February 9), I wrote a message about the number of markets (domestic and foreign) that were starting to bounce off their 200-day moving averages and the likelihood for a short-term rally. The last part of that headline, however read: 'Expect Resistance Near 50-day Average if rally carries that far". Three of the markets I showed in that earlier article are shown below. All three are starting to meet new resistance at or near their 50-day lines. Chart 1 shows the NYSE Composite Index also meeting resistance at its early February peak near 7100. Chart 2 shows the Materials SPDR (XLB) backing off from its 50-day average (blue line) after recovering about half of its early February drop. Chart 3 shows the Energy SPDR (XLE) backing off from its 50-day line as well. [Most of the other markets I showed in that earlier article look very similar]. My "best guess" on February 9 was that stock indexes would continue to trade between their 50-day and 200-day averages which is exactly what they're doing.

Chart 1

Chart 2

Chart 3

COMBINING SIMPLE AND EXPONENTIALLY SMOOTHED AVERAGES... The last paragraph in that earlier article carried the headline: 'Trading Between Averages, But Which Ones". I showed how to combine "simple" and "exponential" moving averages to help find potential support and resistance levels. Since I received a number of questions on the subject, I'm going to delve further into it here. I explained that I usually prefer "simple" moving averages, but that a lot of chartists prefer exponentially smoothed ones. So I showed both on a daily S&P 500 chart as shown in Chart 4. My main reason for doing so was to demonstrate that the S&P 500 had bounced off its 200-day EMA (pink line) even though it hadn't reached its simple (and more widely followed) 200-day average (red line). In my view, that justified a rally attempt to the 50-day lines. But which one? Since I wasn't sure, I showed both. As it turns out, the S&P closed above its 50-day EMA (green line) but has been unable to exceed its simple 50-day average (blue line). So while the 200-day EMA worked better for support, the simple 50-day MA worked better for resistance. That's why it's usually a good idea to know where both moving average versions are located. But there's another reason.

Chart 4

USING EMA CROSSINGS AS SIGNALS ... Exponentially smoothed averages place more weight on recent data and, as a result, hug the price action more closely. Simple averages give equal weight to each day's close and, as a result, are less sensitive than the EMA. That being the case, the more sensitive EMA usually changes direction first. In other words, it turns up first during rallies and down first during corrections. The EMA also tends to rise faster than the simple 50-day ma in uptrends and fall faster during corrections. The 50-day EMA (green line) in Chart 4 crossed below the simple 50-day (blue line) in mid-January (see circle ) and by the widest margin since last summer. That could be viewed as a short-term sell signal. In my view, the 50-day EMA (green line) in Chart 4 needs to cross back above the simple 50-day ma (blue line) to reverse that sell signal. The same principle holds when comparing the 200-day averages. In a bull market, the more sensitive 200-day EMA is usually above the simple 200-day ma which has been the case since last spring as shown in Chart 5 (blue arrow). Chart 5 also demonstrates that crossings of those two averages can provide useful long-term trend signals. So while the "major" market trend is still up, its "short-term" trend is still down.

Chart 5

WHY 50-DAY AVERAGE IS LIKELY TO KEEP DROPPING... Last Thurday's message warned that a "falling" 50-day simple moving average provided more resistance than a rising 50-day line. I wrote that two things needed to happen to turn the market's short-term trend back up again. First, the S&P needed a close above the (blue) 50-day line. Secondly, the blue line needed to start rising as well. I received a number of questions on the second point, so I'll explain a bit more on the direction of the 50-day average. One of the features of a simple moving average is that it "drops off" prices a set number of days in the past and adds new ones. A simple 50-day average "adds" the latest closing price to the sum of the last 50-days' closes, and "subtracts" the closing value 51 days in the past. In order for the 50-day line to rise, the latest price has to be "higher" than the price 51 days ago. Chart 6 shows why that's unlikely to happen. The vertical blue line shows the S&P 500 closing price 51 days ago at 1095 (December 9). As you can see, prices start to rise sharply from that lowpoint to mid-January. That means that the prices being "dropped off" from the 50-day calculation are starting to rise. Unless the latest S&P 500 values being added to the 50-day average can match those higher prices, the 50-day line will drop. The fact that the S&P 500 is backing off from the 50-day line, combined with the likelihood of the 50-day line continuing to drop, suggests that the two week rally attempt may have run its course. That keeps the market in a trading range between its two moving average lines (the 50-day and 200-day). Ultimately, one of them will be broken. And that will determine the direction the market intends to take.

Chart 6