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Be Ready to Act on this Signal, Right AwayBy Jeff ClarkThursday, August 26, 2010 Prepare to get whipped, again.
As we approach the end of August, it's time to take another look at my favorite long-term trending indicator – the monthly chart of the S&P 500 plotted against its 20-month exponential moving average (EMA).
When the S&P is trading above the 20-month EMA, stocks are in a bear market. When the index is trading below the line, the bear is in control.
The indicator triggered a bear-market signal at the end of June. Then it reversed and triggered a bull-market signal at the end of July. This sort of whippy action is rare. But as I wrote at the time, it's not out of the question when most of the action in the market comes from high-frequency trading and algorithm-based computer programs.
It looks like we're going to get whipped again…
 As of yesterday, the S&P 500 was trading 26 points below its 20-month EMA. So unless stocks can rally 2.5% in the next four trading days, we're going to trigger another bear-market signal at the end of the month. Right now, it appears the bear has the upper paw.
But not so fast…
A 2.5% rally in four days isn't out of the question. Stocks are sufficiently oversold, and many technical indicators are at extreme levels that often precede a strong short-term rally. We can't put the bull out to pasture just yet.
No matter where we end the month, however, the signal should be actionable right away. This is different than how we treated the previous two signals. When the bear signal triggered at the end of June, stocks had been falling for two months straight. The best course of action was to wait until stocks experienced an oversold bounce and then sell or short stocks into that strength.
When the bull signal triggered at the end of July, the S&P 500 had rallied over 9% in one month. Stocks were overbought. So I advised that rather than chasing stocks higher, it may be better to take the month off and wait for the September signal.
The decline over the past three weeks has relaxed the overbought conditions. So if we get a rally over the next few days and stocks end the month above the line, we can buy stocks aggressively in accordance with the bull-market signal.
On the other hand, if the S&P 500 ends September below the line, the bear is back in control. This time, however, stocks are not nearly as oversold as they were at the end of June. Any sort of a bounce we get over the next few days will push the index back up toward the line and give us a lower-risk short-selling opportunity.
Either way, we'll have some trading to do on Wednesday next week.
Best regards and good trading,
Jeff Clark
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