Friday, March 14, 2014

Moving Average Crossovers and Shopping for Market Bargains

So imagine you are following all common stocks trading across the major U.S. exchanges and you track how many each day are crossing above their 20-day moving averages and how many are crossing below their 20-day averages.  If you take the net number of crossovers each day and track on a rolling five-day basis, you'd get a chart that looks like the above.

You'll notice that thrusts in crossovers to the upside have tended to lead price peaks in the market.  Troughs in the number of crossovers have corresponded with a number of short-term bottoms.

After yesterday's rout, you can see we're in the range of many of those troughs.  Indeed, since 2012, when (as yesterday) the net five-day number of crossovers has fallen below -1000, the next five days in SPY have averaged a gain of over 1.4%--about four times the average five-day price change over that period.

There are plenty of current geopolitical factors that could erupt and turn the recent decline into a deeper dive, so one cannot blindly assume that the future will mirror the past.  It's when tape action begins to confirm historical tendencies that you have a potential good short-term trade and NRK goes shopping.

Further Reading:  How Trading Systems Can Inform Discretionary Trading

1 comment:

SSK said...

Hello Brett,
In the link at the bottom of this post is a link to a post entitled “How trading systems can inform discretionary trading” In your concluding paragraph of that post you state, “There are limits to human discretion: The best trades are not always the ones that feel the best.” I would agree, and say that almost always they are the ones that don’t feel the best. One caveat to that though, is that through the years of implicit exposure to patterns that feeling can change. For instance, now when the market are rotating toward daily or hourly reference points, I get excited when red bars lead to reference points getting ready to go long, or vice versa. Same is true when the market is trending and a counter move occurs, it is exciting to buy or sell the respective counter move. It was not that way in the early part of my learning curves, and it is important to remember and relate to those past experiences, so that you can quantify not only the growth you have experienced , but while also maintaining the ability to tame the amygdala. The brain likes to project a linear path when processing information. In other words, if it is processing red bar after red bar, it defaults to the simplest common denominator, it likes to think fast, (a great book, “thinking fast and slow” by Kahneman makes many fine points in that area), and that in the market is usually bad, as it mostly it looks to project the trend of what it is currently processing. Also, thinking against its default mechanism can trigger fear. Joseph Ledoux has some excellent research on extinction and recovery experiments regarding how difficult it is to train the brain and its subcomponents like the amygdala, and how it reacts to emotional stimuli. One of his points in one of his lectures is quite germane, quoting “the amygdala which is important for the control of so called fear responses can be activated in people by so called emotional stimuli without any awareness that the stimulus is present and without any feeling of fear”. Maybe that is why it is easier to sell at lows, and buy at highs compared to the opposite entries that so often are harder to enter like buying lows or selling highs in a rotating market. He makes another great point quoting “also people can be expressing fear responses to a stimulus without being aware that the stimulus is present and without having any feeling of fear”. You could probably draw a correlation of that point to traders that have a great track record of framing the market for potential direction, seeing patterns play out over and over, but are yet unable to engage the market. That would seem germane to the point Joseph makes regarding emotional responses that are independent of conscious awareness.
Thanks again for the interesting articles, Best, SSK