The chart below is a daily chart of the S&P 500 going back to the beginning of 2008. The dotted bands represent both 2-standard deviations above, and below, the 50 day moving average. As you will notice, in bearish trending markets (2008) the market tends to trade between the 50 dma and the lower standard deviation band. In bull markets, prices tend to remain between the 50 dma and the upper standard deviation band.
However, prices tend to stay confined between the upper and lower standard deviation bands over short term periods. I have also noted the upper trend line resistance that has been in place since the 2009 lows along with the original trend line support. The market changed from a bullish to bearish trend in 2011 during the debt ceiling debate as a much deeper correction was in the making. However, monetary interventions by the Federal Reserve halted the sell off and started a subsequent market rally that has remain confined by the original trend line support which has now become overhead price resistance.
The bottom part of the chart above is a relative strength index (RSI). I have drawn vertical dashed lines from the lows in the relative strength index to the lows of the S&P 500 index. Currently, the RSI is at levels that are normally consistent with short term bottoms.
It is very likely that the recent selloff has reached a short term bottom. A rally back to the 50 dma, or an attempt at previous market highs, is entirely possible.
Longer Term Concern
As an investment manager, my primary goal is to stay allocated with the market as long as the market is in a positive, or upward sloping, trend. However, it is also my job to reduce portfolio risk when that upward bias is broken. Therefore, I am much more interested in weekly data analysis which smooths out the day to day “noise” of market volatility. As you will notice in the chart above, there are numerous signals over the course of the last few years which would have substantially increased portfolio turnover. However, by smoothing the data, as shown in the chart below, the number of portfolio actions is reduced.
As with the previous chart above, the weekly price data of the S&P 500 is banded by 2-standard deviations. As I stated previously, and more clearly shown here, is that during bullish trending markets prices trade between the moving average (50-weeks in this case) and the upper 2-standard deviation constraint. It also remains the same in bearish trending markets.