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50/200 SMA Crossover

Since we have been pretty sure the market was headed lower over the summer months we will discuss a topic tonight that has always been a pretty reliable signal of bearishness.  I have learned over the years not to trade against the 50/200 SMA crossover.  

We showed many charts over the course of last week and pointed out the 50 SMA crossed over the 200 SMA to the downside on many individual charts as well as the Nasdaq and SOX index.  We mentioned that this one indicator is one of the most powerful indicators of bearishness we know of.  When this formation appears on any chart you must never be long the stock or market and if you are an aggressive trader it is the signal to be short.  In Stan Weinstein's book Secrets of profiting in Bull or Bear Markets (listed in our resource section as one of the books we highly recommend reading) Stan points this crossover out as very bearish as well.  

When stocks are in bull mode we want to see the moving averages layered in sequence on top of each other with the shortest time period being on the top.  For example when looking at a chart we want to see the price of the stock above the 9 EMA with the 9 EMA being the highest moving average line followed in succession by the 20 EMA 33 EMA 50 SMA 200 SMA and any other SMA's you chose to use.  

If all these averages are lined up in this manner we have a very strong up trending stock.  This all works in reverse for bear markets or bearish charts.  Using this same example for a bearish chart we want to see price below the 9 EMA with the 9 EMA being the lowest EMA on the chart followed by the 20 EMA (which is higher than the 9 EMA) followed by the 50 SMA and the 200 SMA being the highest of the moving average lines.  When all these lines are in descending order the stock is in a major down trend and should be shorted.  

Do the Math
The later example is the condition of many charts at this time in this market and this is why we have been recommending cash or being short the market.  We have taken a few long positions when we have expected a counter trend bounce. The stocks we have chosen to be long have excellent chart set ups and the risk/reward favored the position.  There will always be some stocks that go up even in bear markets but if the prevailing trend in the overall market is down the odds favor shorting stocks as opposed to being long the few stocks that are going up.  We want the odds in our favor at all times and when 75% of stocks are going down we lessen the odds of profitable trading if we chose to try and pick the 5% that are going up. 

5% Wait a minute the math isn't adding up you might say. If 75% of stocks are going down then shouldn't 25% be going up Well in bear markets when 75% of stocks are going down chances are 20% are trading flat (not moving up or down). 

It is harder for stocks to move up in bear market selling pressure so in bear markets a strong stock maintains its price but does not necessarily go up.  This leaves only a rare bread of exceptional stocks going higher (like LBIX 16% gain today) and that percentage may be as low as 5% of the overall market.  While we will search and play the few movers we find on the long side like our LBIX alert today we know the odds are not in our favor if only 5% of stocks are going up in a market downtrend.  These trades are an exception to the rule. 

Then when do we buy
When stocks hit the bottom and bounce they will be below the 50/200 SMA crossover and the charts will look very negative.  So how do we know when to buy stocks if we should not buy when the 50 SMA is below the 200 SMA The answer is simple: we will never catch the exact bottom using this method but there will be signs that a bottom has been put in and a new up trend is starting.  There are too many points to make about finding a bottom for this commentary but one sign is when the smaller moving averages start to cross above the 50 SMA and the 50 SMA starts to slant up or at least stop going down.  When this happens the stock or index is near a bottom.  That is the time to start buying because if we wait until the 50 SMA crosses back above the 200 SMA we will miss a lot of the move off the bottom. 

The bottom line is at some point we have to buy while the 50 SMA is below the 200 to make the monster gains off a bottom of a market or stock but now is certainly not the time and it probably will not be time for awhile yet.

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