When a major index falls below its 100 day moving average, investors and traders begin to worry. That is precisely what happened last week with the S&P 500 as it slipped from being unpredictable to moving in a bearish direction. Over the course of a week, the S&P lost 3.8 percent of its value. The NASDAQ ended up losing 4.1 percent in the same period of time.
These are concerning numbers, and in many cases, they are indicative that prices will drop even further. Moving averages present a kind of steady gauge on where prices are going and help to smooth out the swings that trading creates on a day to day basis. As a general rule, the price stays pretty close to the long term moving average, but when a price drops below the moving average, it is indicative that consumer confidence is gone and a further drop could occur. If the price breaks above the moving average line, then consumer confidence is higher and prices can keep going up.
The moving average line represents an average of where prices have been, in this case, over the course of the last 100 days. There are two types of moving averages, simple and exponential. The simple moving average weighs each of the trading sessions uniformly. How the market acted 100 days ago is given the same importance as how the market acted 3 days ago. In an exponential moving average, the further back you look, the less importance the price is given. Current events are weighted more heavily than those further back. In both instances, the moving average line represents a stable price, one that is determined not by volatility, but by what has happened and what keeps happening. A smooth line like that of the S&P 500 is considered to be a reliable technical indicator. Again, this is precisely why the drop below this line is so concerning.
The thing to watch for is if the S&P is able to break above this line over the coming week. If it does, then there’s potential for it to gain traction and stay above, thus negating the ill effects of last week. If it stays below the line, or moves even further away, then the bears will begin to show signs of stirring again and it could contribute to further falling prices. As we move closer to the holiday season, this will be extremely tricky as prices tend to warp from their true value. In other words, it’s time to be careful.
Yes, it’s far too early to say that we are in a bear market, but there are growing signs that this is what is happening. It’s also far too early to determine whether or not this bear market–if it does occur–will last for a month, a year, or longer. These are all up to other circumstances, many of which haven’t even happened yet. Instead of fretting about it, the best course of action is to acknowledge what is happening and prepare your trading portfolio for price drops. If you are a swing or position trader in the stock market, it may be time to think about pulling money out. Day traders might need to think about going from a long to a short strategy. Binary options can be used to help offset trading costs and commissions here in the major stocks and allow you to profit from falling index prices, too. Really, the key is to just have a plan so that you are not going through a period of time where your portfolio is losing money and there’s nothing that you can do about it. There’s always something that you can do.