In this recent post Huge New High, Can We Go Higher? I made some educated guesses based on some indicators about what the market would do over the short-term. I finished the post with these remarks:
My best guess, using these indicators? The market consolidates, pulls back slightly, less than 2%, and then continues the up trend. I will start looking for a more meaningful correction if the percentage of stocks trading above their 20 day moving averages gets closer to 80.
That was written exactly one week ago, tomorrow (or today, if you are reading this on Friday the 14th). I’ll save the congratulatory patting-of-myself-on-the-back for later.
What I really want to talk about is the indicator that shows the percentage of stocks trading above their 20 day moving averages. I speculated in that previous post that once that number got closer to 80 that I would be looking for a more meaningful correction. Upon second thought, and testing of that hypothesis, a more meaningful correction has not typically followed readings near 80 or above.
Let me demonstrate.
The indicator on which I am focused is represented by the green line. I have added trading arrows to the $SPY chart to show where the buys are made.
Buy $SPY at the close if
- the % of stocks above their 20 day moving averages was not above 78 yesterday but is today
I also added a requirement that the % of stocks above their 50 day moving average must be above 75 (but plotted the results separately).
The trades were closed at the close X days later.
Caveats: The setup has only enough samples to be statistically significant to 5 days out from the buy. By the time the results get to 50 days, the average is being generated from only 14 samples.
The setup with the added variable requiring the % of stocks above their 50 day moving average to be above 75 reduces the number of samples to 16 on day one and 7 on day fifty.
Ignoring the sample sizes, the intermediate term appears to be very bullish, while the short-term picture suggests that a small pullback is in order.
I am somewhat fascinated by the results shown when the % of stocks above their 50 day moving average is bullish and the % above the 20 day moving average is bullish. When both are in agreement, it suggests a strong trend that shrugs off short-term mean reversion. I suspect that if I ran the same test and required the % above their 50 day moving average to be low or bearish, we could expect a strong pullback in the near-term, but that is only a guess.