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Market Falls Into Short Term Support Once Again at Trader’s Narrative

A few months ago we looked at the behavior of the stock market when it roams too far away from its long term trend line: What Happens This Far Above The 200 Moving Average?.

Usually when the relative distance from the 200 moving average hits +20% the market has a tough time pushing ahead as it has. On September 16th 2009 this simple metric hit +20.27%. Then it went above the 20% Maginot line again on September 22nd, October 14th, 15th and 19th.

Historically, the market has a tough time moving ahead in the medium to short term when things get that over extended. But this time, we truly went into nosebleed territory as the S&P 500 pushed ahead 80 points or +7% from the mid September high. That’s fairly rare.

As of Friday’s close the S&P 500 is now floating merely 8.6% above its long term trend so we are back in a more “normal” space. However, this doesn’t really tell us much as this indicator is only useful at either extremes.

Last week when we looked at the potential for this correction, I showed a chart of the percentage of S&P 500 stocks above their 50 day simple moving average. During this cyclical bull market they have been able to carve higher lows, suggesting a healthy bull market punctuated with intermittent corrections. Right now we are at 40%. If we drop another 10% points we’ll be below the previous cycle’s low and the trend will be broken.

Here’s an even more short term indicator from the same family, the percentage of S&P 500 components trading above their 10 day moving average:

percent spx above 10 day MA Jan 2010

As you can see from the chart above, we are once again back into oversold in the short term. The market should bounce here. Of course, I use that word ’should’ tongue in cheek because the market doesn’t have to do anything in particular nor listen to any one trader. What I mean is that during this rally we’ve seen the ‘buy the dip’ mentality emerge exactly at these points.

At the beginning of July 2009, mid August 2009, September 2009, October 2009, and again at the end of October and beginning of November 2009. If we don’t see the market follow this well worn script then it is an indication of a change in tone.

In case this support doesn’t hold, then the next area of support on the S&P 500 chart is the 1040-1030 area.

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