Using The 20-Day Moving Average

This is the weekly version of Market Sparks. Here you will find items of general interest to active stock market traders. The weekly is free for all subscribers, alerts during the week are reserved for paid subscribers only.

THE BIG IDEA

It’s hard to read anything about the stock market these days without mentioning tariffs, so let’s get it out of the way from the start: Tariffs!

It’s also hard to employ the usual trading tactics when the world economy depends on one person possibly reversing himself. Or even re-reversing himself. Nevertheless, we are going to go off the board and look at an idea you might want to use, assuming normal times eventually return.

Many traders regularly use the 20-day moving average as one of their trading tools, even if they don’t realize it. It is the core number underlying Bollinger bands, one of the more popular technical indicators.

Today I am going to demonstrate a second-order use of the 20-day average, which you might make use of to perk up your trading results.

The percentage of S&P 500 stocks that are above their 20-day average is a market statistic available on a number of platforms. On stockcharts.com you can find it with the symbol $SPXA20R. One day last week this statistic hit a low of 2% - only 10 stocks in the S&P 500 were still holding above their 20-day moving average!

The reason I am highlighting it today is that something interesting happens when you take a 10-day average of the percent of stocks above their 20-day average. On the chart below, the black line is the S&P 500 and the red line is our indicator.

The actual level of the red line is not necessarily the important thing; it is the turning points. A simple strategy of buying when the line turns up and selling when it turns down could give you reasonable results. Depending on your risk tolerance and your ingenuity, you might add some more detail to it. Moving averages are always a little late to the party and then there are those little fishhooks that could knock you out of a trade. Some possible adjustments:

• Only buy/sell when the turn comes below/above a particular level

• Shorten/lengthen the moving average period

• Require a move of more than X percentage points from the turning point before executing a trade

• Use a MACD crossover on the indicator to generate trading signals

• Tops and bottoms are rarely mirror images of each other, so you could tweak the rules differently for each side

And BTW, this indicator will almost certainly not be turning today. It could happen this week, depending on how the market behaves.