Yesterday the S&P 500 closed right near its much talked about 200 day simple moving average; the closing print for the S&P 500 was 1377.51 and the 200 day moving average closed at 1380.71. As we are once again at this crucial support for the S&P 500 I wanted to take a moment to discuss when big such technical indicators are worth watching and how to manage a position around them.
A question I often ask myself is whether technical analysis works because all traders looking at the same indicators results in a self fulfilling prophecy, or if it simply works because it works. It may not necessarily matter nor will we ever find out the answer for certain, but often enough the odds of technical analysis work in our favor. We can however dramatically improve our at-bat results if we know which indicator to apply to which index or stock.
In the case of the S&P 500, the 200 day simple moving average has a strong tendency to act as support or resistance and hence is track-worthy for traders and investors. That is in stark contrast to the 50 day simple moving average, which has a less than stellar history of being able to act as support or resistance on that particular index.
The two charts below are of the S&P 500 and the Nasdaq 100, both marked with their respective 200 day simple moving averages. If you look at the trading action each time the index gets near the moving average you will note how much choppier the Nasdaq 100 reacts. In other words, the Nasdaq 100 shows significantly less respect to its 200 day moving average than the S&P 500 does. And that leads me to the main point; technical indicators are not created equal for all stocks. Every stock or index has its own characteristic and it is our job as traders and investors to track which indicators work best for the stocks we follow. This applies to moving averages, momentum oscillators, trend-lines and many more technical indicators.
Certain indicators (such as the 200 day moving average) sometimes seem to carry more weight than others for all assets. Frequently however that is in large-part due to mentions by the media and main-stream analysts, who have a tendency to focus on the obvious. Which technical (or otherwise) indicator to focus on depends mainly on its historical track record of being useful for any given security, and not how loud certain media discuss its relevancy.
Back to our current example of the S&P 500 and its 200 day moving average. How does one manage a position around such a crucial level without getting stopped out at exactly the wrong time? Acknowledging that in this case the indicator has a good track record of acting as support/resistance we need to consider the risk of a little overshooting past the moving average, only to stop out investors with weak hands and reverse right back in the direction of where it came from. This can be avoided by not keeping your stop orders too close to the indicator, in this case the 200 day moving average.