Friday, December 14, 2007

When markets go bad

Moving averages are the simplest trend measuring tool to be found. The following two charts show clearly how market health has changed from a cyclical bull market into a more bearish, counter rally structure. Plotting the percentage of stocks which trade above their 50-day and 200-day MAs, for both the Nasdaq and S&P, gives a good indication to the overall health of the market.

When the market is in healthy bull form the percentage of stocks trading above their 200-day MA should be greater than the percentage trading above their 50-day MA. Why? In bullish markets, the faster moving average trades above the slower moving average. In this situation, it is not uncommon for a stock to trade below the 50-day MA, as it might do during a bullish consolidation, without violating the slower, longer term average (200-day MA).

In a bearish market environment, the slower moving average trades above the faster moving average. During counter bear rallies it is common for the faster moving average (50-day MA) to be breached to the upside, without mounting a test of the slower moving average (200-day MA). It is clear in the charts for the Nasdaq and S&P that the rally from August lows was a counter bear rally - and not a continuation bull market rally as witnessed in Spring and early Summer.

It is still possible to enter and exit at lows and highs during bear markets, the point to consider is the shorter duration of bear market rallies. For 2007 the early year (bull) rally lasted five months, the most recent (bear) rally just three.

Buyer beware.