Trader’s Narrative

When I mentioned the bubblicious state of the Chinese market I trotted out the factoids that their indices are trading at astronomical levels relative to their respective long term moving averages (200 day).

But this sort of tell is not very reliable. For one, tops are, by their very nature, notoriously difficult to pinpoint. Unlike their counterparts, they are not borne from meteoric flashes of panic and fear. Instead, they can just peter out slowly over time.

And for another, eventhough an index can seem to be levitating dangerously above its 200 day moving average, that moving average can be hurtling up as fast to reach it. Although seemingly precarious and unstable, it can go on and on. The same way a basketball just keeps going around and around the rim and only just as everyone is tired of watching, falls into the basket.

Here are the historic extremes of indices above and below their 200 day moving average:

Nasdaq 100 Index

• in March 2000 the index was +58% above its 200 day moving average
• in April 2001 it plumbed the depth of -53% below its 200 day moving average

We all know the famous bubble top occured in March 2000. In April 2001, the market bounced from a very oversold level but only momentarily. It soon rolled over into another down leg.

S&P 500 Index

• in October 1982 it hit a maximum of +21% above its 200 day moving average
• in September 1974 it hit its minimum of -28% below its 200 day moving average

The October 1982 instance is a good example of the moving averages moving higher and catching up to the index, and reducing the extreme distance to a normal one. The SPX continued to move higher (this was the end of the bear market of the 1970’s and the start of the next major bull market).

Dow Jones Industrial

• in July 1933 the Dow reached +50% above its 200 day moving average
• in July 1932 the Dow hit its minimum of -39% below its 200 day moving average

The historic reading of oversold in July 1932 corresponds with the bottom of the great bear market of that time. And the reverse, the July 1933 reading was met with mostly range bound trading as the index slowly resumed its advance and continued to lift off the bear market low’s of the previous year.

For the historical data, I’m indebted to Jason Goepfert, from SentimenTrader.com