Sunday, June 24, 2007

Broken 50 Day & 10 Week Moving Averages

You'll never see me post a daily chart on here without the stock's 50 day moving average (dma) plotted (or almost equivalently the 10 week moving average on weekly charts) and there's a good reason for that. This simple indicator is the average of the previous fifty day's closing prices (or previous 10 week closing prices) and reflects the intermediate term trend. For the argument's sake let me try and define a few potentially otherwise vague terms. Any equity whose 50 dma (which should be almost identical to the 10 week average) is rising and below the current price is up trending or in a "rally." The opposite is true for any equity whose 50 dma is declining and above the current price. Take a look at the Dow Jones Industrials 2 year weekly chart and plotted 10 week average for example:

This curve tells us how the Dow Jones has been trading more recently relative to how it was trading 40-50 trading days ago (8-10 weeks ago). For healthy up trending equities it is perfectly normal for prices to stay above the average as institutional investors often buy near this price in support of the stock's uptrend giving this benchmark real value in the eyes of technical traders. So long as prices stay above this dynamic average it should continue to rise and the stock remains in an uptrend.

Back on March 20th IBD had an interesting article about the importance of these averages, I'll quote them:

"If a stock falls below one of those levels, then rallies higher, it tells you that big institutional investors are stepping into buy shares. On the other hand, a stock that falls below its 10 week or 50 day moving average and fails to rally back above that line or continues to head south, may continue to sell off."

As you can see from the Dow Jones 2 year weekly chart above and the S&P 500 daily chart below, these average have just been breached. In fact they were just breached in the last few hours of trading last Friday. Notice what happened the last time this happened circled in blue.

More from the IBD article:

"In addition to the price moves, keep an eye on the stock's volume on the day it drops below its 50 dma. If volume picks up substantially as the stock slices through one of those lines, it's a sign that banks and mutual funds are selling shares. Without the buying power and support of big investors, a stock will have a hard time bouncing back."

When it becomes obvious that these supporting averages are lost that's when the waterfall begins and a sharp move to the downside ensues. I wouldn't throw in the towel just yet on the broad market, but tomorrow is decisive. Also I wouldn't wait for the Junes lows to be broken before getting short either (as some have suggested), if it starts to look like the DIA and SPY are not going to close above their 50 day moving averages tomorrow (Monday 6/25) I would get very bearish in the intermediate term.

Generally speaking, the 50 day and 10 week moving averages provide a quantitative way to define an uptrend or a downtrend and many, many market watchers agree. At least that's what you see in the charts. When these averages break volumes spike and prices drop sharply which is all the more reason to watch closely Monday.

Now for a few individual stocks. WFR is one I have been all about shorting since it broke it's 50 dma last April on earnings. Following that move the stock has vacillated back and forth about this average but has been spending more time below as can be gleaned from the 50 dma's declining value. Click on the chart below:

To me WFR looks right at the "proper short sale point" according to William O'neil's book on short selling:

PHM is a good example of how price action looks relative to the 50 dma in a down trending stock. This stock's biggest declines come when it first slices through the supporting average or bounces off an attempt to recover the declining 50 dma, in other words, when it acts as resistance to upward progress:

Finally, if you haven't yet. Take a moment to read betweenthebars' updated post on COF below. I think that story makes sense on a number of levels and he makes a great fundamental argument for shorting the stock. Since his initial post the chart has made downward progress and frankly I think this is a great play, here's an updated chart:

On a final note, as bearish as things may seem be careful to not get into a crowded space. It seems as though many market gurus are calling for a top and a decline next week seems inevitable. When things seem certain in the market the opposite almost always happens because if everyone is on the same side there's no one left to move the market in that direction. There are good reasons to short this market right now (more reasons here), but when you have Barron's calling a market top on the front page of their weekend paper you have to be suspicious.

Disclosure: I own WFR July 60p & 55p, also COF July 80p

1 comment:

pythagoruz said...

Looks like I wasn't the only one who noticed: