The Market Has Topped! Here’s Why.

Huh.

Your first sign that the title was a load of crap written solely for maximum clickatude is that I used an exclamation point. Only snake oil salesman and Timothy Sykes (but I repeat myself) use exclamation points in their titles. Your second sign that the title is simply bullshit is my post from last night where I wrote about how bull markets are bad for blogging. If those first two clues weren’t enough and you still haven’t figured out how unserious the title is, note the reference to Timothy Sykes in the body of this post, which can only have one purpose: to drive maximum traffic through agitation of the yahoo finance message board rejects.

Now that I have your attention…

I do have something more serious to discuss tonight, and that is the fact that the S&P 500 has traded above its 50 day simple moving average for 46 days. 

Using this statistic as a setup, I’ve come up with a simple little study that should help us determine how much longer this market can trade before correcting.

The Rules:

• Buy $SPY or $SPX at the close when it has traded above its 50 day moving average for 46 days.
• Sell $SPY or $SPX at the close when it closes beneath its 50 day moving average.
• All $SPY and $SPX history used. $SPX history goes back to 1928.
• No commissions or slippage included.

Results Using $SPY:

The equity curve above was generated from trading the setup as a system with starting equity of $10,000.

• Number of Trades: 26
• % of Winning Trades: 19.23%
• Average % Gain / Loss: -0.44%
• Average Number of Days Held: 29
• Number of Days in Largest Win: 159
• Number of Days in Largest Loss: 13

The stats are telling us that if you are waiting for a close beneath the 50 day moving average to sell, there is a substantial chance that the market will be lower than today’s close when that happens. On average, it has taken the market about 5 weeks from this point before it closed beneath the 50 day average, but sometimes it trades higher for much longer (159 more days) and sometimes it starts to correct almost immediately (13 days).

Let’s Look at Results Using $SPX:

• Number of Trades: 107
• % of Winning Trades: 30.84%
• Average % Gain / Loss: 0.25%
• Average % Winning Trade: 5.32%
• Average % Losing Trade: -2.01%
• Average Number of Days Held: 30
• Number of Days in Largest Win: 213
• Number of Days in Largest Loss: 7

Looking back over 80 years, this setup seems to catch one good trade every decade or so. The rest consistently lose. What I find remarkable is that the average number of days the trade is held is stable over the long term and shorter term at roughly 30 days. If this pattern holds true, we can expect some weakness to begin in late March or early April.

But what if we wanted to be sure to catch the big winning once-in-a-decade trade while not losing too much on the rest? The answer is simple, really. We want to make sure we hold our winners longer while still cutting lose the losing trades before they kill the account. Here is what that looks like.

The only thing different is that now we are selling on a close beneath the 100 day moving average, rather than the 50. This change means our average trade is held for 84 days after the setup (versus 30). Look at how this simple change affects the average winning and losing trades:

• Average % Winning Trade 11.81% (vs. 5.32% for selling beneath 50 day average)
• Average  losing trade -3.53 (vs. -2.01% for selling beneath the 50 day average)

This illustrates what happens when we hold winners longer while still selling losers for a reasonable loss. In real-life, most people find it incredibly difficult to hold winners long enough. This may be because their emotions override their knowledge, or because they don’t have enough knowledge to be able to override their emotions.

And that my friends is how you blog during a bull market.

 

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