Is This the Ultimate Sell Signal?

Jared Levy, Editor, Smart Investing Daily
Tuesday, 21 June 2011

stock crash Last week I discussed the chance of a major drop in the S&P 500. And for the past couple of months, Sara and I have accurately warned of sell-offs and market corrections. After all this selling you would think we would look at the bright side of the equities markets… unfortunately there is more bad news.

We may have just gotten the ultimate sell signal.

Those of you who have read or watched my commentary for some time know I am a fan of technical analysis and am an ardent statistical observer. In fact, I made a career out of numbers. It’s not because I believe in some secret mathematical code that controls the stock market, but rather I use numbers to find patterns in human behavior.

You don’t have to be a psychologist. With a smidgeon of knowledge, math reveals the truth behind human logic.

The 200-Day Moving Average

The world of technical and statistical analysis of stocks and options is massive and complex. There are many folks who study much more than I and have dozens of computer algorithms running in unison trying to figure out the market’s next move. It does not have to be that difficult.

Yesterday on CNBC, I must have heard the word “moving average” mentioned at least 20 times in a matter of two hours. Specifically, experts were referring to the 200-day exponential moving average (EMA) of several stocks, but one, Apple, was very popular.

Apple was the stock du jour and was on everyone’s radar because it fell below the 200-day moving average of about $316. Once this happened, the stock quickly dropped another $5, stabilized and closed right at $315.32 (the 200 EMA is $315.88, according to freestockcharts.com).

There are two major moving averages that traders use to determine if a stock or index is in a bullish or bearish trend. The 200-day EMA can be a major support or resistance level for a stock.

Some investors keep it ultra-simple; they buy a stock once it gets solidly above the 200-day EMA and sell it once it falls below it.

The 50-Day Moving Average

The 50-day moving average is more volatile but can provide a stronger early warning of a change in a trend and can also help identify the end of a trend.

Some traders will wait for the 50 to cross above the 200 as an entry signal, then wait for it to cross back below for confirmation that the trend is over and it’s time to sell.

If the trader has a good profit on his hands, he may sell simply when the price of a stock closes below the 200-day moving average.

Let me show you an example…

Below is a daily chart of Apple going back to January 2009. The yellow line is the 50-day EMA and the red line is the 200-day EMA.

The last time Apple was below its 200-day EMA was in April of 2009; the stock was trading at $111. Soon after that, the 50 EMA crossed above the 200 EMA — a signal to buy.

Since then the stock has never closed below its 200-day SMA… until yesterday. The trade has worked out, but now may be the time to look for an exit in Apple — at least until it gets back above that 200-day EMA.

Apple moving average chart
View Larger Chart

(Sign up for Smart Investing Daily and let me and fellow editor Sara Nunnally simplify the market for you with our easy-to-understand articles.)

Apple’s Misery Has Company

Unfortunately, this has become a common theme in the marketplace. I ran a scan of the equity markets to find how many stocks had fallen below their 50- and 200-day moving averages. I also searched for stocks that have seen their 50-day moving averages cross below the 200-day.

It’s not pretty. Here are the numbers…

Out of all the 6,798 publicly traded companies in the U.S. (data courtesy of finviz.com):

(73%) or 4,929 stocks are below their 50-day moving averages
(47%) or 3,180 stocks are below their 200-day moving averages
(31%) or 2,099 stocks have 50-day moving averages below their 200-day moving averages

Remember, this is an extremely broad measurement. When I narrowed the search down to the S&P 500 stocks, I found the numbers were slightly lower, but still relatively high considering we are supposedly climbing out of a recession.

Many stocks are not that far away from falling below one of these major moving averages and if they do, sharp sell-offs can often follow.

Know what your stock’s charts look like and where the major averages are. It can only help you!

The Invisible Hand

What concerns me most is technical analysis has a very strong following and can influence the equity markets in big ways.

Algorithms that run on big computers at powerful hedge funds and trading firms around the world pay close attention to these common moving averages. If a stock breaks out above or below an average, it can trigger thousands of buy or sell orders and can have a dramatic effect on prices.

I have seen it with my own eyes and have many friends in the business who rely heavily on technical analysis to make their money. It’s a serious game, and if many of these stocks fall just a bit further, it could trigger more selling.

Look at how Apple sold off yesterday on NO news and in a bullish market. Do you think it was coincidence? I don’t think so…

Whether or not you believe in looking at the charts, you would be a fool not to. At least learn the basics so you can spot any potential support or resistance points for your investments.

P.S. This kind of mathematical analysis is the backbone of my WaveStrength system. I recently put together an in-depth report on the subject that shows how you can use these techniques to give your portfolio a double-digit boost.

Follow the link to get your hands on my recent report.

Article brought to you by Taipan Publishing Group. Additional valuable content can be syndicated via our News RSS feed. Republish without charge. Required: Author attribution, links back to original content or www.taipanpublishinggroup.com.