Time-tested technical reason stock indices did not collapse yet
I would like to offer one time-tested technical reason why stock indices did not repeat Jan 2016’s global crash like any investors feared last month. By setting up a single moving average line, I make some observations of previous price action for S&P500, Straits Times Index, NASDAQ 100 and NZX 50.
Alternate title: Why there was a stock market crash in Jan ’16 but not in Jan ’17.
Technical setup – a moving average roadmap
In this monthly chart of S&P 500 going back to 1997, I inserted a 12-month exponential moving average line in red. You can also use following:
- On weekly chart insert 52-week exponential moving average.
- On daily chart insert 260-day exponential moving average (take away 52-weekends, 260 is roughly the number of trading days in a year).
Why 12-months, 52-weeks or 260-days? This is a very simple unit of time that we are totally familiar with, this is a unit of measure of financial performance (financial year).
The idea is very simple, in a bullish market where prices are rising, price should be trading above the lagging moving average line. In a bearish market the opposite should happen. Until the line is crossed, trend does not change.
The monthly, weekly and daily moving average lines you apply to different time frames are likely to have different values. In this application, a precise value is not important – we use it as a roadmap to guide us. In any technical study we use on the financial market be it trend line, horizontal value or moving average, price has a nasty habit of near-miss, exact hit or overshooting anyway. This is because we are dealing mostly with anxious people (thank goodness algos have not entirely displaced traders yet). So again precision is not important.
I call this a time-tested roadmap because as you can see from the chart, price complies to the moving average for long periods. During uptrends, price bounce off the 12-month ema because it acts as support and in a downtrend, it serves as resistance. Trend changes when a monthly candle crosses the red line.
SP 500 price action complies very well to the 12-month exponential moving average road map. There were occasions when it overshot the roadmap and then moved back across very quickly. When price was caught in a range, the red line was ignored – rules of moving averages apply here.
Why was there a market crash in January 2016?
You realise from the chart that since the middle of 2011, the S&P 500 was booming along above the 12-month moving average, the line served as support on several occasions. For the first time since mid-2011, S%P 500 crossed the red line at the end of August 2015. This lined up the stars for traders who were looking for a sell signal. When there was another bearish month at the end of December, January was the follow-through action.
This is a monthly chart of the Singapore Straits Times Index (STI) set up in the same way over the same duration 1997 – present. As you can see, the Straits Times Index complied to the red 12-month exponential average in the same way we saw in S&P 500.
The Straits Times Index crossed the red line earlier in June 2015. That’s because the Singapore stock market’s negativeness didn’t start because of Black Monday – it started way earlier when the Shanghai – Hong Kong connect bubble burst in June 2015.
Different starting point in 2015 but same outcome in 2016. By December ’15, the Straits Times Index was already below it’s 12-month ema so traders saw a downtrend. January crash was again a follow through action only. If you go back to my STI postings late 2015, many were already very negative.
Why didn’t stock markets crash last month?
Go back to the S&P 500 chart. Look at the price action from mid-2016 to present. Then look at this chart of NASDAQ 100. After moving through a difficult sideway period early last year, NASDAQ 100 rallied strongly into the end of the year. Both NASDAQ 100 and S&P 500 are now moving bullishly so far away from the 12-month moving average that we are unlikely to see the trend-changing crash we saw last year. If markets do fall, we are more likely to see a 5-10% correction which will be arrested by the moving average acting as a support.
Look at this chart of the very strong New Zealand NZX50 index. This chart is in my opinion a very good reinforcement what I am trying to convey here. It is an absolutely amazing unbroken uptrend so far.
So will there be a crash at all?
There are 2 distinct groups of investors and traders in the stock market.
One group looks at charts like I do. We try to detect bullish signals to buy, bearish signals to sell. Bearish signals are the kind you can see in S&P500 and NASDAQ100 at the end of August 2015. It is the same signal like the one you can see at the end of June 2015 in the Straits Times Index.
Based on the kind of signal we are looking for, there is no bearish sell signal at the end of 2016 for the stock markets shown here and no sell signal at this moment.
The other distinct group of people looks at fundamentals like Price to Earnings Ratios, Earnings Per Share etc. There may be or may be not bearish signals for this group. I don’t know.
What I know is very simple. Markets may not rise forever but it is very difficult to predict when. The best time to do something is when a sweet spot appears that shows tremendously attractive risk-reward propositions. I don’t know what the group of fundamentals people see right now but I do know that for those in the technical group like me, the market is showing a very bullish setup that is totally unlike end-2015.
Note: I believe there are explanations for things that happen to the stock market. They could be fundamental or technical. Explanations can also be found in other studies. Some people also believe in conspiracies such as an invisible all-powerful hand holding up the market. There could be extraterrestrial lifeforms controlling global exchanges or lizards dressed in human skin walking among global elites. LOL. This method I offer here is not the only method but it is the way I see the market right now.