Sell in May and Go Away?

05/04/2010 12:01 am EST

Focus: STRATEGIES

Drew Birenbaum

Editor, PortfolioTilt.com

April was a positive month for the S&P 500 as prices rose 1.5% during the period. However, we are quick to recall the old Wall Street adage, “Sell in May and Go Away.” The bears have been quiet for months and only recently have shown signs of vigor. Will there be more to come?

We will begin with the long-term S&P 500 monthly outlook. Prices are plotted over a time frame that includes a complete bull and bear market cycle.

Key trend line support moved up 20 points for the month and currently sits at 1084.

Let’s examine April's action in greater detail by looking at a few basic characteristics of the price bar. First and foremost, prices closed definitively in the lower range of the bar. This is a sign of weakness because although the bulls were able to drive prices higher during the month, they were unable to sustain the advance and prices ultimately retreated.

In addition, the actual height of the price bar for April was relatively small. A taller price bar signifies a period when one side of the market is in complete control of the price trend. However, as price bars "shrink," they give subtle clues that the strength of the bulls/bears may be incrementally weakening. As a result, their ability to move prices higher/lower diminishes rapidly.

This chart paints a very clear picture of the bullish primary trend. The 12-month moving average line is sloping higher and prices are trading above this support level. Although the markets may run into some headwinds over the short/intermediate term, over the long term, this advance shows little signs of slowing down.

chart
Click to Enlarge

We can put together a more detailed picture of the underlying market trend by examining the weekly charts of the major stock market indices.

During the prior week, the NASDAQ led the way to the downside as prices fell nearly 2.8%. This was followed by a decline of 2.5% on the S&P 500, and 1.7% on the Dow Jones Industrial Average. Clearly the speculative, higher-beta names were hit harder as volume rose substantially in those issues. In contrast, volume on the Dow—albeit heavy—did not exhibit the patterns of institutional distribution seen on the NASDAQ and S&P.

For now, it is critical that one keeps a very keen eye on intermediate-term market action. We will continue to give the trend the benefit of the doubt, as prices continue to trade above intermediate-term trend line support and key moving averages. A change in trend is likely to occur when one or both of these levels has been violated, but there is no surefire way to anticipate when this is going to happen. However, the warning signs are beginning to pile up, and we must be quick to act with conviction once we have identified the proper start of an intermediate-term correction.

Article Continues on Page 2

|pagebreak|

As we pointed out in our April 29 update, the market is forming a trading range of intermediate proportions, and a downside breakout could very well signal the beginning of a change in trend.

chart
Click to Enlarge

chart
Click to Enlarge

chart
Click to Enlarge

The short-term trend channel we have been following has been violated on our S&P 500 cycle chart. The next likely support area has been circled in blue. This area corresponds with the prior intermediate high. Notice how after the initial breaking of the trend line, the decline halted and prices turned up to "kiss" the bottom of the trend line before reversing to the downside. This type of pullback occurs fairly often, and offers an excellent short selling opportunity for astute traders who can act quickly on the pattern.

chart
Click to Enlarge

The Dow Jones Industrial Average is very close to testing prior resistance at the last intermediate high. The bulls are hoping to draw a line in the sand here and form a new support level. The Transports, on the other hand, are far extended above this respective level, and would have to undergo an extensive decline to reach this support zone. Regardless of this fact, it would be wise to keep an eye on the support levels circled in green on both of these indices.

chart
Click to Enlarge

Our simple, yet effective ten-/40-week EMA crossover system on the dollar continues to show positive results. Prices rose .5% for the week and confirmed a new multi-month closing high. As long as the ten-week moving average line trades above the 40-week MA line, we will maintain a long position. Profits will be taken only when these lines cross; and because this system is always in the market, a reverse (short) position will be executed.

chart
Click to Enlarge

All investors and traders must stay in tune with the action of the general market indices because underlying market action accounts for a substantial portion of the movement in an individual security. Keep in sync with the market by following our updates.

By Drew Birenbaum of PortfolioTilt.com

Related Articles on STRATEGIES