Time to take a dif­fer­ent tack

Warn­ing signs of tricky trad­ing con­di­tions

Financial Mail - Investors Monthly - - Analysis: Technical -

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.

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