The MACD – Buy or Sell on this Indicators Predictions?
The 50-Day Moving Average – A Bearish Sign?
May 21, 2012
“.....Last week, however, was a big disappointment from a technical perspective, as equities broke support.....The S&P 500 Index (SPX - 1,295.22) not only fell below potential support at the 1,340 level -- an area that acted as resistance on multiple occasions last year.....The Russell 2000 Index (RUT - 747.21) fell below the 780 area.....The CBOE Market Volatility Index (VIX - 25.10) advanced above the 21 area.....”
- Delta-Hedging Effect on the Stock Market, May 21, 2012
“.....It has been a punishing last six weeks or so in the stock market – and markets continued to decline last week, erasing most of the gains achieved since the middle of January. For the first time since January 18, the S&P 500 traded below.....and early rally attempts fizzled quickly. It is important to note the deterioration in the technical picture since late March, when....."The risk of a deeper correction remains high.....”
- The Week Ahead in the Stock Market, May 21, 2012
Stocks continued to fall last week, and the S&P 500 Index (SPX) is down about 7% over the last three weeks. This is causing some discussion about indicators that are breaking down, and suggesting rough times ahead. The indicators may sound scary -- but frequently, when you look at the numbers, they tell you nothing about what is to come. One such indicator was easily observed earlier last week, when a downturn was analyzed in the SPX's 50-day moving average.
The 50-Day Moving Average
The 50-day moving average is a very commonly followed moving average. As such, it can be a nice mechanism for following trends. If the stock you are following is above its 50-day moving average, this can be considered bullish (and vice versa if the underlying is below that trendline).
This analysis is taken a step further to check out what direction the trendline is moving to get an overall feel for how things are going. Of recent note on the S&P 500 Index (SPX) is the fact that its 50-day moving average recently turned lower after trending higher since November.
On the surface, it would be expected that this would be a short-term ”bearish” sign, but that isn't the case at all. In fact, since 2000, this has actually been a bullish event! As you can see below, the overall returns from a 50-day moving average that is pointing lower after a month of trending higher actually beats the at-any-time returns across the board.
Two of the last three times this has happened, the move lower in the trendline has come within days of marking the eventual trading lows for that move. In other words, it's been a very good time to get very long.
The MACD Sell Signal and the SPX
“…..The moving average convergence/divergence (MACD) histogram for the S&P 500 Index (SPX) on a monthly chart officially moved above the zero line on Thursday, March 01…..and suggests the overall uptrend is still firmly in place for the bulls…..compare this with when we had a MACD sell signal back in September…..”
-MACD – A Technical Buy Signal, March 5, 2012
Moving on to the week ahead, observation of the MACD indicator on the SPX weekly chart provides more insight to market strategies – this is of an opposite of what was observed early March – see excerpt above.
The MACD calculates the difference between two moving averages (typically, the 12- and 26-period), and then finds a moving average of that difference (typically, a 9-period moving average).
In the bottom chart below, the red line shows the difference between the two moving averages, while the dotted red line is the 9-period moving average. The histogram shows whether the MACD line is above or below the dotted line. Many analysts call it a sell signal when that histogram turns negative, which just happened recently. The top chart shows the SPX, and marks prior instances when there was a buy or sell signal based on this indicator. Since signals can happen fairly frequently during certain times in the market -- within this study the first signal only is shown over any given three-month period. Taking a quick look at the chart, the buy and sell signals seem to be mixed. Some of them were good signals, but others were pretty bad.
Understanding the Results
It is not always a bad sign for the market when a MACD sell signal appears on the S&P 500 weekly chart. To quantify this result, an observation of what has actually happened going forward after one of these sell signals, by going back to 1990 to find the dates of all such buy and sell signals to see how the market performed afterwards.
The third table shows the typical returns for the SPX since then. This is one of those cases where it's misleading to call it a sell signal. The market actually performs better than average after a "sell" signal, and even outperforms the "buy" signals.
However, it is to be noticed in the MACD/SPX chart above that the MACD line is at a pretty high level. That suggests that the market had been performing very well, and some might say it was leaning overbought. Therefore, by further study, by looking at MACD sell signals on the weekly SPX chart -- but only considering signals that happened when the MACD line was above 15 -- this left just 12 signals -- but the returns after those signals were great times to buy.
Just because it's called a sell signal does not mean you should sell. The analysis above shows that the MACD on a weekly SPX chart has been a terrible indicator to follow. In fact, the kind of "sell" signal that the market has produced most recently has marked huge buying opportunities in the past, so it shouldn't be a surprise if this one is, as well.