Nov 03
Moving Averages Signal Breakdown
Posted by Kristjan Velbri | Posted in General | Posted on 03-11-2009
Russell 2000, the market index for small cap stocks signaled a clear sell signal today as moving averages confirmed the breakdown of the uptrend that I’ve been talking about (here and here). On daily charts, I use the 19 and the 39 day exponential moving averages, which give way better signals than the all too often used 20 and 50 combination (the 20-50 combination is good, but it has a nasty time lag, which I don’t like, I prefer to be in the know when change happens, not weeks after something has already taken place).
I know that a new trend has been started when the 19 and 39 day EMAs cross below the 50 day EMA. So far this hasn’t happened. Keep in mind that moving averages don’t always work. Back in July, they gave a sell signal but the market continued moving upward (they didn’t remain in the ’sell zone’ for long, though). Moving averages are a great way to recognize new trends or the breakdown of old trendlines, but they should not be used in isolation. The high probability way to go is to use trendlines and a small handful on customized indicators. By customized I mean that you should tune the time periods to your own taste. I don’t find it very useful to use default settings.
Where to from here?
Well, first I would like to see the S&P 500 perform a similar EMA breakdown. Then, for confirmation, I would like to see both the 19 and 39 day moving averages of both the S&P 500 and Russell 2000 cross below the 50 day EMA. That would be a strong confirmation of a new downtrend. Here’s a 3 year chart of Russell 2000 with 19 and 39 day EMAs to give a little perspective of the effectiveness of the signals (note that the ’sell’ and ‘buy’ markers on the chart are not on the spot where the price was at the time the signal was initiated, they are a bit off). Remember, not one trader is right all of the time. But you don’t need to be right all of the time, you need to be right most of the time, which is exactly what this combination of EMAs offers. Used with indicators, they are a charm.
