Phoenix Envy (SPY)
The market will move in the direction the majority least expect, for a duration that no one can predict, reversing precisely at a time that the greatest number are blindsided.
Or as a wise investor once wrote, “The market’s raison d’etre is to reach as deeply as possible into the pockets of average investors and empty them.”
It’s for that reason that professional investors developed tools to protect themselves.
And one of those is the ‘moving average’.
Here at Normandy, we use a proprietary selection of moving averages that have often raised eyebrows, but we use them for a simple reason: they work.
After settling on them some fifteen years ago, we’ve employed them unstintingly to read market direction, and we believe they’ve made an outsized contribution to our industry beating track record over the years.
We want to offer a word now on moving averages in general, 1) because we regularly get inquiries regarding our own, odd quartet of MAs and 2) because of late, they’ve once again proven themselves righteously accurate.
The bottom line on MA’s is this…
Like so much in technical analysis, once a particular indicator becomes accepted by the mainstream, it moves from being a simple detector of some underlying technical condition, to creating an inevitable response to that condition.
In other words, the indicator takes on a self-fulfilling role.
Let’s use an example to illustrate.
Take a popular pair of tools, nearly universally employed – the 50 and 200 day moving averages.
It’s a truth broadly acknowledged that when the 50 day moving average crosses below the 200 day MA, it’s best to be out of the underlying investment vehicle, and the reverse when the 50 DMA crosses above. The bearish case is further strengthened when the crossover occurs while both 50 and 200 DMAs are trending lower, and the bullish case is strengthened when the crossover occurs as both MAs are trending higher.
By the way…
The bullish occurrence has come to be known as a ‘Golden-Cross’, while the bearish is often dubbed an ‘Iron-’ or ‘Death-Cross’.
Take a look here:
This is a chart of the last six months’ action on the iShares High Yield Corporate Bond ETF (NYSE:HYG). The cross lower (circled) occurred while both the 50 and 200 DMAs were also trending lower, adding urgency to the bearish call.
And the results (in blue) speak for themselves.
When technicians see such a ‘Death-Cross’ they almost always jump into sell mode, moving as a herd and often bringing about a greater panic than might normally have occurred. In such an instance, other indicators, like the RSI (Relative Strength Index), will have to be monitored to determine if and when an oversold condition is ultimately reached, and a ‘buy’ signal has been triggered.
The Whole Truth…
Yet there’s another side to the coin – and equally important.
After an indicator has been adopted by the masses, it quickly loses its predictive ability, as investors attempt to front-run the signal and take pre-emptive action in anticipation of the turn.
Using the chart above as an example, an investor anticipating a death-cross in HYG might have started selling his stock as early as October.
It may even be the case that if enough investors front-run the signal, the bulk of the selling will have been completed by the time the indicator actually flashes, thereby creating a false signal, befuddling the masses and fleecing them of their hard earned investment dollars (more on this below).
The real truth on moving averages, however, is not as many suppose.
Outside of the conventional 50 and 200 day markers that the majority of technicians use as support and resistance levels and that serve adequately for that purpose (precisely because the majority are in agreement regarding their efficacy), any two moving averages intelligently chosen to fit the investment’s time horizon will suffice.
That’s right. Any two will do.
So long as they effectively incorporate the investor’s goals, one short and one long will generally provide adequate entry and exit guidance.
So Why the Exotic MAs at Normandy?
Some have questioned our use of the 137 and 411 day moving averages here at Normandy, and, to be honest, the truth behind their use borders on the mystical.
Here’s the quick and dirty:
- The number 137 is a prime number;
- It’s also part of the Fibonacci sequence; and
- It has special significance in Hebrew numerology, where it’s closely tied to the concept of waves.
For a quick look at modern physics’ enchantment with the number 137, do a Google search using ‘137’ and ‘physics’. It might lead you here, to Nobel Laureate Richard Feynman’s lifelong obsession with the number and his belief that it could be instrumental in tying together all the disparate aspects of the study of physics into a single, Grand Unified Theory (GUT).
For us, it’s neither occult nor grand – it simply works. As a marker of longer term support and resistance it’s better than any moving average we’re aware of.
And it may have just signalled the bottom of this most recent down-wave, too!
Here’s a chart of the S&P 500, as represented by the SPDR S&P 500 ETF (NYSE:SPY) –
And as you can see, support arrived precisely at the 137 day line. A surge in volume (in blue) and a move higher from RSI and MACD indicators (in green) also offer support for the bounce hypothesis.
And that also forms our basis for the trade of the day.
But before we get to it, we have one open initiative to report on.
It was launched on January 23rd in a letter called Washington Redeemed, wherein we urged you to buy the SPY July 20th 250 PUT for $2.91 and sell the SPY July 20th 240 PUT for $2.03. Total debit on the trade was $0.88.
The 250 trades for $7.43 and the 240 for $5.77. Sell the former and buy back the latter and you net $1.66 on $0.88 spent. That’s a gain of 88% in three weeks, or 1525% annualized.
The timing is perfect to close out that bearish bet and reopen a short term bullish one using SPY.
And it goes like this –- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Wall Street Elite recommends you consider selling the SPY March 2nd 260 PUT for $2.87 and buying the SPY March 2nd 250 PUT for $1.52. Total credit on the trade is $1.35.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew