How the Stock Market Is Like a Dog on a Leash

Includes: DIA, QQQ, SPY
by: Babak

You know how, when you’re walking a dog, it pays no attention to the path or sidewalk and instead, driven by the instinct to collect and archive as many smells as possible, zig-zags to the left, then pulls to the right? It takes as much distance on the leash and as much of your patience as you allot it. Then you tug it back onto the path and the whole routine starts again.

Well, the market is a lot like that - a moving average being the leash, and price being the dog. Here’s a chart of the S&P 500 relative to its 50-day moving average - I haven’t included an actual price index but I’m sure you’ll have no trouble matching the inflection points to important market tops and bottoms:

The above graph can be misinterpreted. So let me clarify: Just because it peaks and turns down doesn’t mean that price has to. It may, or the average can rise/fall to close the gap and/or the S&P 500 can meander sideways.

A good example of such an exception would be October 2006 when the market, by this measure at least, got really extended. But even so, it was able to grind higher, almost methodically, for another four months.

So to be clear, I’m not saying that the market is now definitely extended too much above its 50-day moving average. Potentially it still has room to go up. But at the moment, if it keeps up this pace, especially the tone set Thursday and into Friday, it won’t take too long for it to get there.

Just something to tuck under your hat. And by the way, this doesn’t necessarily eliminate the long-term bullish prospects for the market. This technical metric is useful in the medium term, which means that we can use it to watch for pauses or corrections within a much longer term bullish rally - similar to this other market breadth metric.

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