Indicator of the Week: The S&P Moving Average Bulls Shouldn't Ignore

One S&P 500 Index (SPX) moving average seems to be a clear buy signal

Senior Quantitative Analyst
Feb 24, 2016 at 7:33 AM
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Stocks are starting to show some signs of life again, with the S&P 500 Index (SPX) gaining over 6% since it bottomed about two weeks ago. The index recently crossed above its 40-day moving average and will most likely soon cross above its 50-day moving average. It got me wondering: If I looked at various moving averages, were there any that would give an all-clear signal to buy stocks?

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Moving Averages: The most common moving averages typically referenced are the 50-day, 100-day, and 200-day trendlines. As contrarians, we also consider less common moving averages, like the 40-day and 80-day trendlines. Our reasoning is, if the crowd is looking at the 100-day moving average as some sort of signal, then watching the faster 80-day should give us the signal before them.

For this analysis, I took a very simple approach. I went back to 1950 on the S&P 500 and found times when the index was below the moving average for at least a month and then crossed above it. Then I calculated the returns going forward over different time frames. Hopefully, a particular moving average will stand out as kind of an all-clear signal to buy stocks. I looked at five different moving averages -- the 40-, 50-, 80-, 100-, and 200-day -- and I also showed what the typical SPX returns have been since 1950.

The chart below shows the average return of the S&P 500 after it crosses above the moving averages. The 80-day moving average leads the pack in the shorter term. The 40-day moving average crossover -- which just occurred on Monday -- has the worst returns over the short term; the average return over the first week is actually negative.

It's interesting how the returns all seem to converge at the two-month time frame, near the market's typical 1.4% return. After that point, the performance breaks apart some and once again in the longest-term time frame (six months), the 80-day moving average leads the pack and the 40-day moving average is the worst.

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Next I have a chart that shows the percentage of returns that are positive after crossing over each moving average. By this measure, again, the 80-day trendline has the best performance in the short term with about 75% of the returns positive over the next month. What's interesting in this chart is that each percentage positive at the longest time frame (six months) is below the percentage positive typically seen at any time. It's as if a crossover of the moving averages (except the 40-day) provides a short-term boost to the index which then dissipates, ultimately showing a percentage below what is typical.

What's also interesting is that, in the short term, the 80-day moving average crossover has been a pretty good buying signal. One plausible theory is that investors are anticipating a bullish crossover of the very popular 100-day moving average, accelerating buying around this time. Currently, the index needs to gain 4% to get above the 80-day.

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