How to gauge the downside in the S&P 500

• Posted by Greg Harmon
• on July 28th, 2015

Is the next stock market crash coming? I do not think so. Correction or Pullback, whichever you want to call the current downward move in the S&P 500, it seems the broad market is anticipating more. My friend Ryan Detrick points out the fact that the move higher is in its 7th year, and this has only happened 1 time previously in history. Another, Jeff Hirsch, points out a possible 3 Peaks and a Domed House topping pattern.  Neither is fear mongering, just taking notice, but all we need now is a Hindenburg Omen!

The concern all seems a bit premature to me for a Index that is 7 points, less than 3.5% off of its all time high. But hey, I am game to jump in. One chart that I like to look at to assess the potential for a pullback or correction is a chart of just 3 simple moving averages (SMA). The chart below shows the 50 day (green), 100 day (purple) and the 200 day SMA’s (red) of the price of the SPDR S&P 500 ETF, $SPY.

With out any other indicators or the noise of the daily price fluctuations there is an interesting set of data to review. Since December 2007 there have been 6 instances where the 50 day SMA has crossed down through the longer SMA’s. The first 3 times, resulted in the 50 day SMA crossing through both the 100 day SMA and the 200 day SMA. These resulted in corrections of roughly 57%, 18% and 22%.

When the 50 day SMA crossed the 100 day SMA but stops before touching the 200 day SMA the pullback has been shallower. This has happened 3 times as well and resulted in pullbacks of 11%, 8% and the 9.9% one in October last year.

This leaves a simple lesson to watch for. On a 50 day SMA cross through the 100 day SMA, look for a pullback of around 10%. But continuation through the 200 day SMA and it it time to look for 20% or more. One final note. The 50 day SMA is yet to cross through even the 100 day SMA yet in this crash, or correction, or pullback, or maybe wimper.

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