Why The 50-Day Moving Average Is A Great Technical Indicator

Since mid-April, one of the strongest industry sector ETFs in the market has been Market Vectors Semiconductor ($SMH). We initially bought this ETF when it broke out back in April, sold into strength for a 9% gain several weeks later, then re-entered with partial share size after it began pulling back (May 23).

As the broad market has been consolidating and digesting its recent gains over the past month, $SMH has been holding up well and we remain long our partial position from the May 23 entry. However, now that the 50-day moving average has finally risen to meet the price of $SMH, we are also prepared to add to the swing trade position, in anticipation of a pending resumption of its new uptrend and a breakout to a new 52-week high.

Below is the daily chart pattern of $SMH:

As you can see, the June 13 intraday low in $SMH nearly coincided with a kiss of its rising 50-day MA (teal line). When an ETF or stock with relative strength breaks out of a base, the first subsequent pullback to the 50-day MA typically presents a low-risk buying opportunity because it is this level where institutions often step back in to buy.

Rarely will the first retracement to a 50-day MA that follows a substantial breakout fail to hold up on the first test (although “undercuts” of one or two days are common). As such, subscribing members of our swing trader newsletter should note we have listed $SMH as a potential buy entry. Please see the “Watchlist” section of today’s report for our exact trigger, stop, and target prices for this setup.

In this June 6 blog post, we pointed out the “triple convergence of support” that was forming in the S&P 500. Specifically, we highlighted how key intermediate-term support of the 50-day moving average, dominant uptrend line, and horizontal price support from the prior highs were all merging together. To refresh your mind, here is the exact chart of the S&P 500 SPDR ($SPY) we showed that day:

The very next day, the S&P 500 “undercut” that area of support on an intraday basis, but formed a bullish reversal candle to close above it. Such a bounce was not surprising, as the more technical indicators that converge to form support, the more significant that support becomes.

After the formation of that triple convergence of support on the S&P 500, we indeed expected a bounce, but also still expected the broad market to consolidate a bit longer before resuming its uptrend. Now that stocks have been trading in a range for the past few weeks, the 50-day moving average has again risen up to provide support for $SPY (just like the $SMH chart). Here is the current snapshot of $SPY:

The charts of both $SMH and $SPY above are great examples of the significance of the 50-day moving average as an intermediate-term indicator of support. However, it’s important to realize that stocks and ETFs are more likely to bounce off the 50-day MA if it is only the first touch of the 50-day MA that follows a convincing breakout from a valid base of support.

Each subsequent test of the 50-day MA that occurs before the index or stock breaks out to another high technically weakens support of the 50-day MA and thereby increases the odds of a breakdown below it. As such, it would be a negative sign for the market if $SPY and/or $SMH break down below yesterday’s lows (which would correspond to a break of the 50-day MAs).

Although our market timing model just shifted from “buy” to “neutral” yesterday, it does not mean the dominant market uptrend is dead. Rather, it simply tells us to take it easy with regard to both the quantity of new swing trade entries AND the total share size (exposure) of new trade entries (Editor’s Note: Due to the bullish follow-through that occurred the same day this article was published, our timing system shifted back into “buy” mode on June 14).

As long as the major indices and leading sectors hold their 50-day MAs while continuing to consolidate, stocks still technically look good for another move higher, which would pick up where the April to May rally left off.