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Stocks Have Little Room To The Upside at Trader’s Narrative

A while back I presented a historical study which looked at the behaviour of the S&P 500 relative to its long term trend line: what happens this far above the 200 day moving average? If you haven’t yet, go check it our for full details because what follows will make much more sense.

When the Dow broke 10,000 (for the nth time) in the middle of last month, I cautioned that stocks had risen into thin air (again). The S&P 500 meandered around 1090 for a few days and then fell back.

Now, once again, looking at the same technical metric, I would be remiss to not issue another cautionary note:

SP500 relative to 200 MA Nov 2009 topping

As of today’s close, the S&P 500 index is 18.6% above its 200 day moving average. That is very close the 20% ceiling that seems to exert an almost magical restraint on momentum.

In the days left in the week we could potentially move up to 1120, which would expand the distance between the close and the 200 day moving average to approximately 21%. That’s really the maximum distance that it has been able to roam away from its long term trend in the past. So that’s about +2% further gain in equities from where we are.

Also, remember that tops that form at the 20% ceiling tend to cluster. So just like mid October, we may see a few days where the S&P 500 hovers around the 1120 area before either dropping as it did before or simply plateauing (to wait for the long term average to catch up).

Although this message may appear bearish in tone, it is only in the short term. If my prediction is borne out, then the S&P 500 will have made yet another higher high (and higher low) - the very definition of an uptrend and a rather beautiful chart formation.

Finally, it seems that every time I write along these lines, someone comments to remind me that the “markets can do anything”. So allow me to nip that in the bud.

Well, yes, of course the market can do anything. I’m not under the illusion that I can restrain them or to make them do my bidding. I’m simply observing a pattern of behaviour that they have exhibited in the past and projecting from that a probability. So I hope that is crystal clear.

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9 Responses to “Stocks Have Little Room To The Upside”  

  1. 1 wayne

    Thanks for sharing your work. A couple of things that come to my mind after studying the chart.

    In both of the 2 recent instances where the S&P moved 20% from it’s 200 MA, the S&P was actually higher a month later (after a one week pullback). So a Bull could probably argue that based on these two data points, you should buy a pullback.

    It would be useful to see a few more data points.

    And maybe a table showing probabilities for SP moves as a function of relationship to it’s 200 day moving average.

    Babak, if we have our friend’s blessing, I will probably see what I can come up with over the next few days. Thanks again for initiating a study idea.

    On a different subject. This Tarp Gap between 1075ish and 1100ish has provided some interesting resistance for the S&P. We went to the bottom of the gap (1075) and pulled back for a few days, regrouped and took a shot at the top of the gap(1100) then sold off in late Oct. They soldoff today after momentarily breaking the gap and trading up to 1103. As a general rule the longer the market works on a resistance line, the less likely it is to continue to hold. I suspect the bears need to get something going tomorrow, else we should move through this level pretty soon.

  2. 2 wayne

    This a lunch time analysis. I’ll let readers make what they want of the following.

    Going back to 1950, there were two other periods where the market reached 20% above it’s 200 day moving average, 750509-750701 and 821020-830509. If you measure from the first day of each of these two periods, here is what I get. (My tabs don’t work in comment box, it should show the one month, three month, six month and one year % change in SP after the first observance of 20% above 200 day moving average.)

    % Change in S&P 500
    Date 1 mt 3 mts 6 mts 1 year
    750509 0.75 -4.98 -1.32 12.53
    821020 -1.58 5.09 15.44 19.93


    1. Both of these time periods show up in lots of screens comparing today’s market to the past as we were coming out of extended bear markets and oversold conditions in each.

    2. Two data points is not enough data to draw a strong conclusion, but in both cases, the market was substantially higher one year later.

    Bears are getting the best of it so far today (12:45) as market continues to have some trouble getting through a strong resistance line at 1102 that goes back to Tarp Gap. It can take time. Market finding some intraday support at the overnight lows. Dull day for most, but support/resistance guys live enjoy this stuff.

    Noticed this morning, that third quarter S&P 500 earnings are going to finish near $15, which should put us in line for $45-$55 for 2009.

  3. 3 Brian

    The SPX 500 index rallied from below it’s lower Bollinger band and from oversold stochastics on November second. The SPX 500 index closed higher for six of the last seven trading days (the only loss was for 0.07 points), to it’s 2009 high and to it’s upper Bollinger band yesterday and with a reading above eighty in it’s stochastics. A short-term correction in the SPX 500 index would not be surprising at this point

  4. 4 wayne

    I am a very uncomfortable short in here for at least thru tomorrow.

  5. 5 biscosc

    I’m not comfortable trying to top tick such a young bull market. Too much risk and better just to get on-board with the major trend and keep riding. Sit tight and be right!! Sure there might be a 5-10% pullback, but it’s just as likely we proceed another 5-10% higher before having a pullback and in that case your timing would have to be perfect just to keep up with holding.

  6. 6 wayne


    I have an intermediate and a day model. How to utilize the two is something that I struggle with almost constantly. I use the intermediate for my retirement and mutual funds and the daily for my trading accounts. The daily model has a good 10 year record, is nimble, but the intermediate model has gotten the best of it this year.

    Livermore wrote that it is rare to find a trader who can be right and sit tight. I think he was probably on to something. Cuts commission and slippage as well.

    Intermediate wise, I tend to lean toward the Desmond camp and kick myself every time I lose money on a short.

  7. 7 biscosc

    Wayne -

    Based on your prior posts I’m sure you do quite well with both your models. For me I like Ken Fisher’s thinking of the subject of forecasting. There are only 4 possible outcomes when forecasting - Up a little, Up a lot, Down a little, Down a lot. Unless I can forsee a down a lot scenario then I’m not going to monkey around trying to go to cash. In my opinion, today’s market doesn’t have the characteristics of the next 12 months being down a lot so I’ll sit tight.

    One question for you Wayne. You spent any time analyzing country/sector momentum and making asset allocation decisions based on this?

  8. 8 wayne


    I haven’t done any sector analysis. Did you see this study by one on Ned Davis’s guys on using IPOs to predict sectors.

    My focus has been trading sps and options on sps. I was writing models to estimate option prices on a Mac in the mid 80’s before such software was available everywhere. Incredible price discrepancies in the early days. But I do trade for a living and I am interested in any studies that can help pay the light bill. Sector analysis could be very useful. I’ve been trying to expand my trading horizons for the last decade, but have this unhealthy obsession with the sps. One of those, “the more I learn, the more I realize how little I know” syndromes. I could probably run any string of data through some of my models and get decent trading results. If someone was willing to seed such an effort, we could look into it. I have some studies I’m working on that will keep me busy through 09.

    I closed my short, went home flat. Will cogitate over the weekend on a small long for Monday morning.

  9. 9 biscosc

    Wayne -

    Thanks for the link. I’ll be sure to read it when I have the time. I’m certainly not a professional, but have recently been using my programming background to dabble in a few systems. One in particular is using the average of past 3, 6 and 12 month returns to select countries/sectors/stocks/etc. I’d really like to have someone else with more experience take a look at the output from a few tests to see if the results I’m getting are just too good to be true. If you’re interested we can exchange emails.

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