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With the dramatic, near-parabolic rise in US stock indexes, cries of “overbought” and “too much too fast” and “correction” are coming in torrents via the media. I heard several stories today discussing the divergence in the S&P 500 ($INX or $SPX.X) from its 200-day SMA. Technicians attempt to measure overbought/oversold conditions in many ways and measuring the distance that price pulls away from a moving average is a useful technique. It is straightforward, easy to calculate, and gives us plenty of history.
The charts show the S&P 500, daily, with the 200-day SMA and an oscillator which shows the divergence between the two as a percent of the index. Some of the historical extremes are noted on the charts. The lowest reading was -65.69% on 11/20/2008; the highest reading was just over 17.10% on 10/15/2009. (Daily charts, 2002-2006, 2007-present.)
As of today’s close, the index is 8.52% above the average. In this context, 8.5% is not particularly extreme. Nor do we see any non-confirmation between the index and the oscillator at this time. (Historically, there have been many interesting such non-confirmations.) (Daily chart, 1 year.)
This brings to mind an often-overlooked aspect of many indicators, including moving averages and oscillators such as those used here. We tend to focus on the new data being built at the right of the chart and how it will affect our calculations. But keep in mind that an indicator is impacted by the older data being dropped out of the data series; this is particularly true with a simple arithmetic calculation like a SMA. Said another way, we focus on how price is moving and overlook how the average will move.
This is particularly timely because, over the next few weeks, we will be dropping out closing prices from the June 2012 bottom. These are mostly values between 1305 and 1330. So even a sideways market now would make a big difference in the oscillator as we drop those old prices.
For example, a rough calculation is that the oscillator could drop from 8.5% to 7.39% if the rest of this month is sideways. That is, the condition becomes more neutral as the moving average rises to meet price.
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