Sep 10, 20203 min read

Pygmalion Effects in the Classroom

The 50-day moving average (ma) is an important key level of support or resistance used by many technical traders, quant driven trading models, and computerized trading systems. It is considered technically significant as it is the first line of support in an uptrend or the first line of resistance in a downtrend. Since moving, averages are based on statistical analysis, a moving average is often deployed to help filter or smooth out the noise (price action) thereby minimizing the random outliers on the chart.

The moving average is one of the most popular and commonly used of all technical indicators. Because it so widely available and heavily followed that traders and investors need to better understand the technical implications of the 50-day ma technical breakdown as well as the 50-day ma technical breakout.

There are a few basic rules or tips that a trader and an investor need to understand when using the 50-day ma: (1) securities trading above the 50-day ma is generally considered bullish; (2) securities trading below the 50-day ma is generally bearish; (3) in a primary uptrend if the security declines toward the 50-day ma and bounces upwards, this is positive signaling the resumption of the primary uptrend; (4) in a primary uptrend if the security falls below the 50-day ma and continues to decline further, this is negative and warns of a deeper correction or a trend reversal (to the downside); (5) in a primary downtrend, if the price breaks the 50-day ma to the downside this warns of the next major decline; and (6) in a primary downtrend, if the price breaks the 50-day ma to the upside this hints of an improving trend and possibly a trend reversal (to the upside).

For some traders and investors, moving averages deployed in conjunction with other technical measures can help with the risk management process. For other moving averages can assist with portfolio management strategies. Some may also deploy the indicator as a clear line in the sand discipline for buying and selling positions. For instance, when a security is trending above its 50-day ma, any brief corrections to this level can be a place to add or to buy new positions. On the other hand, when security convincingly breaks below its 50-day ma this can alert a trader or an investor to a sell or rebalance positions.

In the past few days, key US indexes have fallen to or are nearing their respective pivotal 50-day ma. In a healthy trend accompanied by strong market internals, expanding market breadth, price momentum, favorable volume expansion, sector rotations, attractive risk/reward ratios, etc there is a good chance that you will find key support residing along with the 50-day ma. However, in a weak or deteriorating trend, violation of the 50-day ma may warn of the next major sell-off toward intermediate or longer-term supports which may consist of important retracements, trendlines, prior breakouts, and the 200-day ma.

US markets are now headed toward an inflection point. Enclosed below are charts of key US indexes accompanied by their respective 50-day ma, 200-day ma, distance from the 50-day ma, and the distance from the 200-day ma technical indicators.

It is important to understand that because so many professional and retail investors are aware of these technical indicators and many quant-driven trading models and computerized trading systems incorporate moving averages into their risk management disciplines, it would not surprise us that it becomes a self-fulfilling prophecy.

Remember, there are two types of self-fulfilling prophecies. The first is self-imposed prophecies, which occur when your expectations influence your behavior and the second is the other-imposed prophecies, which occur when one person’s expectations govern another’s actions – “Pygmalion Effects in the Classroom.”

Which of the above two scenarios will likely occur as key US stock indexes fall toward their respective 50-day ma?

S&P 500 Index (SPX - 3,339.19)

50-day ma = 3,317.06 (% distance from ma = 0.67%)

200-day ma = 3,096.47 (dma = 7.84%)

Dow Jones Industrial Average (INDU - 27,534.58)

50-day ma = 27,237.70 (dma = 1.09%)

200-day ma = 26,300.68 (dma = 4.69%)

New York Composite Index (NYA - 12,706.69)

50-day ma = 12,634.06 (dma = 0.57%)

200-day ma = 12,417.07 (dma = 2.33%)

Nasdaq Composite Index (COMPQ - 10,919.59)

50-day ma = 10,922.63 (dma = -0.03%)