Why This is An Intermediate Advance in a Long-Term Down Trend
Tuesday, April 8, 2008 | Chris RoweRating:
Want an incredibly simple way to know when it's time to be a long-term bull or a long-term bear?This ex-Wall Street money manager is never 100% bullish or 100% bearish. But I'm about to show you a trick that I hope will make you a more disciplined (and profitable) investor.
Use the 20-week exponential moving average together with the 40-week exponential moving average. Together, they will tell you whether you're a long-term bull or bear. Use them in conjunction with a couple of other indicators, and you'll see the market in a new light.
This will sound oversimplified. But the K.I.S.S. philosophy (keep it simple, stupid) applies to technical analysis.
Here's how it works:
Below is a 4-year WEEKLY chart of the S&P500. (It's very important to make sure it's a weekly chart. Confusing this with a daily chart or otherwise is a common mistake that gives you a very different picture.)
Notice how the 40-week EMA (blue squiggly line) and the 20-week EMA (brown squiggly line) converge and diverge again and again, but the 20-week EMA (brown line) always stays above the 40-week EMA (blue line). Said differently, the 20-week EMA found support at the 40-week EMA (shown at the black arrows). This confirmed the market's long-term uptrend. That is, until January of this year when the 20-week EMA finally crossed from above to below the 40-week EMA (red circle).
This moving average crossover was a confirmation that we were in the "topping stage", and the long-term uptrend was officially over until further notice. Once we saw that crossover, we knew it wasn't just an intermediate-term correction in a long-term uptrend. In fact, we'll see the opposite start to happen now. We'll see intermediate-term advances within a long-term down trend.
What's Next?
The next thing to look for is for the shorter-term 20-week EMA to cross back above the 40-week EMA. At that point, I'll have a more bullish LONG-TERM tone. But until that happens (as well as a couple of other indications), you'll most likely see the 20-week EMA find resistance instead of support at the longer term 40-week EMA as the market trends lower. This is the opposite of what we've witnessed for the last 4 years.
The key here is to understand the difference between the intermediate (weeks to several months) trend and the long-term (several months to years) trend. Always know your stock market posture (bullish, bearish, and to what degree).
SIDE NOTE:
In the same chart above, I've circled in green a weekly MACD buy signal. Weekly MACD buy signals are long-term signals.
A MACD buy signal is seen when the blue line (in the MACD section) crosses above the brown "signal" line. When weekly MACD buy signals are seen as the market is in a long-term uptrend, they are signals to increase bullish exposure to the market because it will likely advance higher. When they are seen as the market is in a long-term down trend, as it is now, they are signals to reduce bearish exposure for the same reason, but not necessarily a signal to take bullish long-term positions.
BACK TO THE 20 & 40 WEEK EMA
Below is a 4-year weekly chart from year 2000 - 2004. Notice how the 20 and 40-week EMAs act in a long-term down trend. The black arrows point to times when the two moving averages converge (and the 20-week EMA seems to find resistance) and then diverge. Notice the weekly MACD buy signals given, and notice the way the market reacted. All they were was intermediate-term advances followed by a continuation of the downtrend.
The bottom wasn't found until the 20-week EMA finally crossed back above the 40-week EMA. We all know what happened after that. The long-term trend reversed higher. If you follow this simple rule, you're less likely to act on false rallies.
Intermediate bounces can be fun and very profitable. I am certainly not saying that you shouldn't take advantage of them. But know the difference between an intermediate-term and a long-term outlook. We're not out of the woods yet folks. Let these two old friends (and not the media) tell you when we are.
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“Profit from the Trend”
Chris Rowe
Chief Investment Officer
The Trend Rider
