Time to take a different tack
Warning signs of tricky trading conditions
This month we’re focusing on a chart of the JSE Top 40 index and the constituents that make up the index. The focus is specifically on the 50-day moving average and the slope of that moving average.
A 50-day moving average is generally a good barometer of medium term momentum and trend. It takes the closing values of an instrument for the past 50-days and averages those values, and then plots that ongoing 50-day “moving” average on a chart.
Typically, short and medium term traders will look at this moving average as an indicator of whether the trading action in the market is bullish or bearish on a medium term horizon. Fifty days of trading activity represent about two and a half months of trading.
The reason for focusing on the 50-day moving average this month is that it has begun to turn slightly lower during the past few weeks on the Top 40 index. This has happened only five times during the current bull market, which started in early 2009.
The boxed areas on the chart of the Top 40 index show the previous times when the 50-day moving average was pointing down or sideways, indicating weak medium term momentum. What is clearly evident during those times is that volatility increased and the market became choppy, with larger than normal movements. The times between the boxed areas are times when the 50-day moving average was pointing upwards and the market was trending higher with low volatility.
The fact that the 50-day moving average has started to point downwards recently should spark warning lights to alert us that the market looks to be moving into another one of those times where it is likely to become volatile and erratic, making for tricky trading conditions.
We have already seen a fair amount of volatility during May and June, but it seems this may be just the beginning of a period of further volatility in coming months. Often the middle months of the year are choppy and trendless, and it looks as if this year will be more of the same. The saying “sell in May and go away” may be an old fashioned cliché, but it still seems to have some degree of relevance today. Certainly this looks to have been the case in 2015 to date.
The table which shows 20 of the constituents of the Top 40 index shows just how many of the constituent stocks are currently trading below their 50-day moving averages, and how many of the stocks’ 50-day moving averages are pointing downwards.
There are 42 stocks that make up the Top 40 index (Investec and Mondi are duplicated with their dual listings). Of those 42 stocks, 34 are trading below their 50-day moving averages and 30 have 50-day moving averages that are pointing lower. That indicates that the breadth in the market is generally weak and that the bulk of the stocks making up the index are exhibiting weak medium term momentum. The top 10 stocks account for 65% of the weighting of the Top 40 index, implying that the index is heavily skewed towards those 10 stocks. Within the top 10 stocks, only Richemont is trading just above its 50-day moving average but it does look vulnerable to breaking lower. Seven out of the top 10 stocks have 50-day moving averages pointing downwards.
As the 50-day moving average is a lagging indicator, it will require significant gains in the market to drag the 50-day moving average upwards again.
This seems unlikely in the near term, given the seasonality that is usually present in the middle months of the year, and with the market fretting over the prospect of a rise in US interest rates later this year.
Other risks on the horizon include Greece and the potential for a “taper tantrum” when the central banks in Japan, China and Europe begin to scale back their respective stimulus programmes.
There will undoubtedly be good trading opportunities for savvy traders who can capitalise on the volatility, but do keep in mind that a volatile environment does require a different trading approach to the trending market that we have witnessed in the first few months of this year.