Over at least the past two decades, the 20 period monthly moving average on the S&P 500 has been an excellent reference point for bull and bear cycles. When it is rising, you should generally be a bull for the foreseeable future, while you should be bearish when it is declining. When it smooths out, you should grow cautious and wait for resolution. As with all moving averages, it is important to note the slope of the reference point and not just whether price is above or below at any given time. Too often, traders completely ignore the former aspect, while getting caught up in the latter to their detriment.
Another important point is to keep the timeframe in mind for perspective, as multi-day or even multi-week trades can be made counter to the trend above. The 20 period monthly moving average analysis is extremely beneficial to your market posture during largely volatile periods of confusion. As an example, in the summer of 2010 we had a nasty 16% broad market correction. At the time, I posted a monthly chart like the one above over on Stocktwits, noting that even though the market was quite scary and sentiment horribly negative, all that was happening was a pullback to the still-rising 20 period monthly moving average. Note above that we found support right near that rising 20 period monthly.
Unlike the summer of 2010, when we never breached the 20 period monthly, this time around we did. That said, the moving average is still inclining (albeit at a lesser rate), which tends to bode overall quite well for bulls. Moreover, the buyers did an excellent job of quickly taking price back above it.
Based on prior market action, a longer-term bullish to bearish reversal should see the 20 period monthly moving average flatten out while price consolidates below it, before we eventually break lower. I am not impressed with the price action in the current market of late, but the bears still have plenty of work to do before I would say that we are back in a cyclical bear market.Twitter
Great long term view, thanks Chess.
I will test. Good stuff Chess!
Thanks, Wood. Been looking at it a while now for a few years. Would be fascinated by your precise results.
Chess your Wood’s thoughts on the 12 month avg v 20, please.
I like 20 monthly better
PG, there is lots of research out there to support using long moving averages such as the 12 month to avoid big drawdowns. Mebane Faber has a white paper published on the 10 Month Average. A quick google search will turn it up. These long term averages don’t beat the market by much, but they decrease volatility and help you avoid large drawdowns. I’ll get something posted up this week about the 20 month and will run a comparison against the 12 month.
Thanks guys. I appreciate it.
Here’s an interesting and slightly faster moving average indicator: the 13 and 34 ema on the weekly chart. If you call that up over the past 10 years, on the weekly timeframe, you’ll see that it has only whipsawed 3 times in 10 years. Every other cross has led to long sustained moves. Recently it crossed decisively and then pulled back to near proximity before once again both averages turned down with the 13 beneath the 34. I’d love to post a link to the picture, as others do at times, but I don’t know how to do that. Can anyone tell me? Anyway, food for thought…
JakeGint likes that, I believe
Maybe thats where I got it from. I picked it up from someone. That’s probably it.
Thanks, Chess, informative chart.
What was so significant between 1995 and 1996 that starting making the index move steeply during uptrends and downtrends? Also, the moving average is almost making a head and shoulders pattern 🙂
1995-1996 marked the start of the dot-com bubble. On a 40-year log chart, it shows up pretty clearly, as does its unwinding from 2001-2003.