Market slide accelerates, some thoughts on movings averages, gold

Above is a continuation of the S&P 500 etf daily chart that appeared on my last blog post, updated with the prices as of today. I discussed the possibility of a move back up to the moving averages after the big break. I didn’t expect the snap back rally would stop almost to the tick at those moving averages, but on the S&P it did. The big down candle on May 6th looked like at least temporary exhaustion, so some sort of rally could be expected. What is interesting is how the adaptive CCI in the middle sub-graph stayed over the trending plus 100 line (dashed cyan line) for the duration of the persistent rally, then caused a failure swing around the zero line just prior to the big sell-off. Then when the rally back up to the adaptive moving average lines occurred, it failed to push the CCI back into positive territory. It then turned back down from a negative reading just as prices stalled at the moving average. I consider the darker blue moving average to be the main support and resistance line, and the combination of the two determining the trend direction. I also added the double stochastic in the lower sub-graph which also gave a very timely signal of an over-bought condition within the new downtrend. There seems little doubt that the trend has finally come into sync with reality. Trends that only sustain themselves for the sake of their own continuation, which are divergent from the condition of the economic and political environment are doomed to succumb to a quick rush for the exits as soon as the music stops.

A quick thought on moving averages. I read many opinions on the market and technical analysis. Almost everyone I hear or read uses the 20, 50, and 200 period moving average. When I ask them why, their only response is “that is what everyone uses, so it becomes self fulfilling. I have a problem with that line of thought. First, it is true that any of those three moving averages seem to provide support at certain swing points, and once penetrated they do seem to give a good summary of the trend direction. But one can pick any period moving average at random and also find that it will provide support at certain swing points and provide a good indication of trend. Probably different swing point and trend indication, but any moving average will appear to turn back a swing occasionally, and certainly will define a trend. And most randomly chosen averages will define a trend if it happens to be in sync with the ever changing cycles of the market. In fact a moving average is nothing more than a mechanism to filter out the shorter cycles. The problem is the cycles keep changing. So no single moving average can be perfect. So many traders use a combination of several moving averages in the hopes that one will be in sync with the market. That can be fine as long as the trader understands what the moving average is really doing. Blindly following common moving average lengths because everyone else seems to be using them is not logical in my opinion. There is no edge in what everyone can see. I don’t see how it is logical that a trend will turn around when it hits the 50 period moving average on the assumption that everyone will act in some way at that point. That just doesn’t make sense. If there were an edge in such an approach the market would quickly eliminate that edge.

I find it much more useful to use indicators that attempt to adapt in real time to the ever-changing market cycles. The problem is trying to find a method that extracts the cycle the market is attempting to express as that cycle is being formed. If markets maintained the same cycle over a long period it would be easy to pick the best moving average parameters. But the cycles are a constantly moving target. The best work I’ve seen in extracting cycles as they are forming is the work by John Ehlers. The moving averages I’ve been using on the blog are his Mesa Adaptive Moving Average. I just use the default parameters as he has written the formula, which is widely available on the interent, in one of his books, and on his website, as I recall.

And a quick note on gold. This is one market that has fundamentals supporting the uptrend. But a negative development is the failure occurring this week as the market tried to break-out of the swing high from last December. The trend is still up, but so far that break-out looks like a trap. The daily chart is sitting right on the moving average line, so I’ll be watching to see if it provides support. My guess is that the market needs to clean out the excessive bullish sentiment, which would probably be a healthy thing. I’ll try to update as this develops.

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