The most popular stock market indicator has given a “buy” signal. Should you jump in?
Let us examine the issue with the help of three charts.
Please click here for annotated chart of S&P 500 ETF SPY, +1.09% For the sake of readability, the chart shows only the 200-day moving average on the price.
Please click here for an annotated chart of S&P 500 ETF with indicators other than the moving average.
Please click here for a longer-term chart of S&P 500 ETF with a 200-day moving average.
For the sake of transparency, no change has been made to the last two previously published charts above after the original publication. Please note the following:
• The most popular timing indicator is the 200-day moving average.
• As the first chart shows, the price just crossed the 200-day moving average. In traditional technical analysis, this is considered a buy signal.
• Often technically oriented investors stampede into the market when this buy signal is given.
• The indicator derives its power not from anything innate in the stock market, but from the legions of investors who believe in it. It often becomes a self-fulfilling prophecy. After all, why not 150-day or 250-day moving average?
• Technically oriented investors tend to take similar actions based on charts of the Dow Jones Industrial Average DJIA, +1.74% Nasdaq 100 ETF QQQ, +0.42%and small-cap ETF IWM, +1.59% A similar action occurs with popular stocks such as Apple AAPL, -0.22% Amazon AMZN, -0.91% Facebook FB, -0.88% and AMDAMD, +2.38% Investors may want to watch the 200-day moving average on the charts of those four stocks. And investors who want to gain an edge may want to look at money flows. Please see “If you own Apple, Amazon, Facebook or AMD, look out below.”
• In deciding whether to jump into the stock market based on this indicator, in my opinion, investors ought to pay more attention to the second chart linked above. Please see “You can bet that the U.S.-China trade deal won’t help stocks — here’s why.”
• Legions of investors who believe in the 200-day moving average will have an eye-opener if they were to look at the third chart linked above.
• The third chart shows numerous false signals the 200-day moving average indicator has generated. Investors may want to note that believers in this indicator tend to not even acknowledge the false signals.
Read: ‘Investable’ cash, the fuel for the stock market, drops to a 20-year low
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What to do now
Investors ought to bring more sophistication to their investing and use a more complex model such as the ZYX Asset Allocation Model with 10 categories of inputs. The model has performed well in both bull and bear markets. (In 2008, when most portfolios lost one-half of their value, The Arora Report portfolio based on the ZYX Asset Allocation Model produced a positive return of 45.9%.)
Furthermore, investors ought to guard against getting whipsawed by selling when the market falls below the 200-day moving average and buying when the market goes above the 200-day moving average. In spite of the shortcomings of the 200-day moving average, it should be on the radar of every investor.