This stock market bounce has bought us the luxury of uncertainty

07/08/2010 5:42 pm EST


Jim Jubak

Founder and Editor,

So far we’ve got a bounce.

It’s appreciated. The profits, if you’ve made any, are real. Enjoy.

But so far that’s all it is.

Stocks were badly oversold. They’d fallen too far, too fast as how Wall Street puts it. That created expectations that stocks might rally in the short-term. Those expectations became self-fulfilling prophecies as investors who had sold stocks short decided to take their profits by closing out their positions by buying the stocks that they’d previously sold. And as traders looking for a chance to make short-term profits bought as prices moved higher.

But the U.S. stock markets remain precariously close to dropping another stage lower.

Just before this bounce started the Standard & Poor’s 500 stock index was showing signs of what market technicians—who sure do love naming the chart patterns that they see—call the “death cross.” You get a death cross when the 50-day moving average crosses over the 200-day moving average. That’s a sign that the market is head for a fall since when the short-term average falls to cross below the longer –term average it’s a sign that the market as a whole is about to follow. (Moving averages are really pretty simple—now that we don’t have to calculate them by hand. A 50-day moving average is a line that plots the closing price of a stock or in this case an index at the end of each of the past 50 days. Tomorrow technicians will plot the average again—for the most recent 50 days. Which means that each day the average moves as the oldest price drops off one end of the trend line and is replaced at the other end with the most recent day’s price.)

That really spooked some traders.

But experienced technicians—and I’ll readily admit I’m not one—know that the version of the moving average that many traders use, called the simple moving average—tends to give off a lot of false sell signals. In the fall of 2004 and in August 2006, John Murphy and Arthur Hill have pointed out in their subscription “Market Message” on, the simple moving averages showed a clear death cross—only to reverse course and turn positive again.

Murphy argues in favor of a version of the moving averages called an exponential moving average. That indicator has given off only one false sell—in 1998—in the last decade plus that he studied.

That’s significant right now because while the simple moving averages show a death cross the exponential moving averages don’t. These more accurate indicators haven’t yet delivered a sell signal.

On the other hand, they aren’t flashing an all clear either. The exponential 50-day moving average is poised just above the exponential 200-day moving average. It wouldn’t take much to push this indicator to a sell reading. But the stock market could move out of danger in the coming days if, for example, investors hear positive earnings news and guidance for the second quarter reporting season that starts on Monday, July 12, when Alcoa (AA) reports after the close.

I don’t much care what words you use. The market is “testing,” or “poised” or “looking for direction.”

That’s what the bounce has bought us—uncertainty. Sure better than the “certainty” of another leg down in the market. But not actually very reassuring.

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