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Using Moving Averages to Gauge the Summer Ahead


This technique provides intermediate to longer-term clarity of direction.

Welcome to 2012's entrance into summer via a day off, a shortened week, and Spain needing 19 billion euros to bail out its fourth-largest bank, Bankia (BKIA.MC). The month of May has been nothing short of exhilarating as the Dow Jones Industrial Average (^DJI) and the S&P 500 (^GSPC) head for their worst month since November while the Nasdaq 100 (^NDX) is possibly pulling off its nastiest performance in nearly two years.

Surprisingly, even commodities are no safe haven from the equity downfall as oil (WTI – West Texas Intermediate) fell 13% plus and briefly dipped below $90, and gold lost another 7%.

In all likelihood, the tape will continue to be driven by overseas headlines with Greece's possible exodus from the EU, due to the pending June election and the country's inability to keep a promise. No one can accurately portray the magnitude of the ripples in the pond that will be caused by the election results or the probable departure from the EU. However, what we do know is it will create further turmoil and uncertainty.

The equity markets, as formidable as they may seem at times, are rather rational when it comes to definitive information that can be priced in. When the information cannot be clearly defined, then instability, by way of volatility, arises. This is one of those times.

Understanding technicals is a foremost priority when fundamentals are not clearly determinable. Today we examine a longer-term evaluation technique to help ascertain where the market's tendency lies. This longer-term technique is similar to using the moving average convergence-divergence to determine momentum direction and strength. The variation here is evaluating two moving averages through their current slopes and potential cross.

Click to enlarge

Using the moving average slopes and potential crosses can help technicians determine the extent and severity of direction. Assuming three potential market stances (bullish, bearish, and neutral: bull-hedged or bear-hedged), they can use this technique to more adequately determine said stance. Looking at the above example, the shorter-term moving average (or STMA) is sloping down toward the longer-term moving average (or LTMA), which has shifted its slope from positive to horizontal, using a 5% standard deviation margin of error. Thus far this indicates a market neutral (or bullish hedged) stance. Conversely, if the STMA was to cross the LTMA and the LTMA was to begin to slope down as well, this would indicate a shift to a bearish stance.

This technique, somewhat lagging due to it being based on moving averages, does however provide intermediate to longer-term clarity of direction. Adding it to a "stacking of probabilities" model affords greater confidence and conviction toward all decisions. All in all, it helps establish where investors should spend their time when evaluating equities: long, short, aggressive, defensive, and/or hedged.

I hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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