Market Shows the Benefit of Moving Average Levels

May 10, 2010: 10:06 AM CST

This morning’s early activity reminded me of the saying “The market exists to confuse the majority of the people the majority of the time.”

The sharp sell-off confused a lot of people last week, while this morning’s rally confused even more people, making the market an equal-opportunity confuser of bulls and bears.

However, in the context of quickly moving markets, it’s helpful to watch reference levels, and sometimes those levels are from key moving averages.

Let’s take a look:

In a trending environment, key moving averages (I use the 20 and 50 EMAs and 200 SMA) can provide good support levels to put on new trades, or levels to take stop-losses (and consider shorting) once a key level is officially broken.

They’re not magic – nothing is – but because many traders actively monitor these averages, particularly on the daily chart, key tests of these levels can result in short-term “self-fulfilling prophecies.”

That means that if traders see the market testing a key moving average, they will buy and thus ‘create’ support at that average.

Nevertheless, in a trending environment, we see the 20 day EMA as the first line of defense for the bulls/buyers, which held in mid-April (see prior daily posts:

“SP500 Teaches Importance of Rising 20d EMA”

SP500 Bounces off 20d EMA yet again

However, once sellers push price under the rising 20 EMA, we expect the price to then test (trade down to) the rising 50 day EMA for another potential ‘game’ of support.

This happened on May 4th as sellers officially ‘tested’ the 1,170 level.  We then used this as a reference for a potential support bounce, but if sellers took price under this level, we would look for the next test of support at the 200 day SMA at the 1,100 level.

Of course, I don’t think anyone thought that test would occur two days later – the expectation is that we would have traded down over the next few weeks to test the rising 200 day SMA for a major test between bulls and bears.  Thursday’s crash tested… and broke… that level intraday.

When the dust settled, the market found support off the 200 day SMA at the 1,095 level, holding as potential support.

And this morning we see the result of that support test which took us straight up to the falling 50 day EMA at 1,166.

Again, I don’t think anyone foresaw that happening in one day, but that was the next overhead resistance level/target to watch.

The recent daily chart helps underscore the example of using moving averages as reference levels, and reminds us that the market can do anything (a la Mark Douglas’ teachings).

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

5 Comments

5 Responses to “Market Shows the Benefit of Moving Average Levels”

  1. Dan de Man Says:

    Hey Corey,

    I wanted you to know I appreciate all the articles you do which are always very informative. Your absulutely right that moving averages are essential to trading.

    There's a new trading system on stockcharts.com that's good to keep traders out of bad market utlilizing a 13day ema. The “Elder Impulse” system.

    Check out these links:

    http://stockcharts.com/h-sc/ui?s=SPY&p=D&yr=0&m

    http://blogs.stockcharts.com/dont_ignore_this_c

    http://stockcharts.com/school/doku.php?id=chart

    Cheers,
    Dan

  2. gamingthemarket Says:

    This action is very similar to the mortgage bond market blow ups. This time it's interest rate swaps. Eurodollars plunged on Thursday creating a wave in the interest rate swaps market. The largest cash market in the world.

    http://www.gamingthemarket.com/financial-armage

  3. Triple Index Daily EMA Reference Levels to Watch May 11 | Afraid to Trade.com Blog Says:

    […] showed how the S&P 500 ‘respected’ moving averages in yesterday’s post “Market Shows the Benefit of Moving Averages” as reference […]

  4. Doug Jones Says:

    Corey please don't tell me we are heading back to the melt up. It looks like they are buying the dips again!!!. Is is ever going to end? Today 5/11/10 market action looks too familiar. Where are like major popped stops on the S&P?

  5. Corey Rosenbloom, CMT Says:

    Hi Doug,

    It looks exactly like that, from the gap down, melt-up, pause at resistance, and then slice through resistance in classic 'popped stops' short-squeeze mode this morning.

    The 50d EMA is 1,167 and 20d EMA is 1,174.

    Above 1,167 and we pop to 1,174 and above 1,175 and it's game on again for the popped stops melt-up to new highs.