Still working on the 1st of The 5 Principles of Successful Stock Market Investing, we just covered what a Bull Market looks like, and what a Bear Market looks like. But, now, we want to explain what a Transitioning Market looks like, as well as when you might want to be a seller, if capital preservation is your goal.
Look back a couple of posts for the definitions and explanations of the Bull and the Bear Markets, and then, working with the same criteria… those being the price of the S&P 500, and its 50 and 200 day moving averages, we can easily identify what transpires as the Bull Market dies, and a new Bear comes out of hibernation, or vice versa.
Five things absolutely have to happen in order for a Bull to become a Bear… just watch for these. 1.) The price of the stock market index, in this case, the S&P 500, turns down and falls thru it’s own 50-day moving average. 2.) The price might continue to decline and to even pierce its own 200-day moving average. 3.) The 50-day moving average of the price of the 500 rolls over and begins to trend downward. 4.) The 50-day moving average of the 500 declines thru the 200-day moving average to become what is called a “Death Cross.” And, finally, 5.) The 200-day moving average of the S&P also rolls over and commences to trend downward.
If you were inclined to sell, where would you do so? Would you want to be a seller when the 500 fell thru its own 50-day moving average? Not likely. It does that quite a lot, and you would experience a lot of whip-saws, back-and-forth, in-and-out of the market. That’s not going to work. How about whenever the price fell thru its own 200-day moving average? That could actually work. It doesn’t happen too terribly often, and in most cases, it would result in a whip-saw, but not so often that it would cause you to incur too many commission expenses, if you use a broker like eOption, at $3 a transaction, and don’t hold a great many stocks. It might also work to be seller whenever the 50-day moving average began to down-trend, but again, most times it would be a false signal, but not so terribly frequent that it would necessarily break you.
A more realistic approach might be to be a seller on the occasion of a “Death cross” of the 50-day moving average falling thru the 200-day. That’s actually a rather popular selling strategy. To wait until the 200-day was to begin its own decline is typically rather late.
The only other idea, related to the above, is to watch for the price to rise back up thru its 50-day moving average to advance as far as to actually “kiss” it’s own 200-day moving average, and to then fall away; as a confirmation signal that the market has turned into a Bear. However, because this actually did happen the past 2 bear markets, that in no way means that it must or will happen again. There is one other idea…
I recently learned of, and wrote about the professional traders’ use of the 17-month moving average of the S&P 500, and the incredibly simplistic manner in which they employ it. Only if the 500 were to end a month below its own 17-month average, would they sell. This resulted in all of 4 round-trips in and out of the market over the past 20 years, and only one was a whip-saw, which resulted in almost no loss. These Big Boys participated in almost all of the past Bull markets, while avoiding most of the ensuing Bears that followed each Bull. I’ll bring that back again next.
Here’s to your successful investing!
Harold F Crowell