S&P 500: Light green when 50-day moving average above 200-day moving average; Red when 50-day moving average below 200-day moving average.

Our chart illustrates periods when the S&P 500's 50-day moving average (DMA) has been above (light green fill) or below (red fill) the 200 DMA beginning in 1928. The 50 DMA crossover has done a good job of staying on the right side of longer term trends in our view but it is not the most timely indicator - for example, from the March 2009 low it did not signal 'buy' until late June by which time the S&P 500 had already risen 31%. Furthermore, like any price momentum, tool, this indicator gives false signals more than half the time. Its effectiveness is that false signals produce small losses whereas good signals have captured all significant trends. While we still expect support to hold at bottom of the box (the S&P 500 at around 1000), our confidence is being tested by the prospect of a bearish signal.

David Fuller's view Moving averages (MAs) such as the 200-day and 50-day are trend smoothing devices which lag by definition. Consequently they can only confirm what one could have identified considerably earlier in the price dynamics. For this reason I prefer to use MAs for regression. For instance, with trending markets we usually include a 200-day MA (40-week) on weekly charts. If the market is trending upwards but accelerates too far above the MA, it is overbought and a mean reversion back towards the MA can only follow. The reverse applies in downtrends. Overextensions to the MA signal that the market is oversold and susceptible to a mean reversion rally.

Recently, a number of technical analysts have pointed out that the S&P 500 Index's 50-day MA has crossed beneath its 200-day MA. This would be a potentially quite bearish signal if it remained beneath the 200-day MA which also turned downwards more than briefly. You can see the two MAs on this 5-year weekly chart and the pale green 50-day MA is now slightly beneath the still rising but flattening 200-day MA.

Previously, the last bearish divergence occurred in late December 2007 when the 50-day MA crossed beneath the 200-day MA, and stayed beneath it until late June 2009. Given the speed with which the S&P fell to its low in March 2009, the bullish crossover in June of that year was much less helpful than the earlier bearish signal. However the MA crossover will also give false signals as you can see with the temporarily bearish signal in July 2006. On this 10-year weekly chart, you will also note that a false bearish signal also occurred in August 2004.

Subscribers who are interested in MA trend-smoothing indicators can create them in the Library for any quoted instrument by using the 'Charting' function shown upper left in the charcoal bar above each graph. (See also yesterday comments on rally potential for oversold stock markets.)