S&P 500 at its 200 DMA: Buy or Sell Signal?

The S&P 500 is at a major juncture – down 10% from its high and below the 200-day moving average. Is this a time to buy the dip or cut and run?

---------------------

Cutting to the chase – a correction is a great time to buy. The trend is up but the price is down enough to offer some value. The onset of a bear market is the worst time to buy (other than the very top) because it means sitting on losses for some time until the market recovers.

Hence the importance of the moment for investing decisions.

The S&P 500 benchmark started its fall at the start of the year and has been trending downward since. It is for now, narrowly avoiding falling into a short-term "correction," defined as a retracement of at least 10% since the last high.

Last Friday, however, it collected a dubious milestone, crossing under the technically and psychologically important 200-day simple moving average (SMA). That was the first time since the start of the pandemic. The more tech-heavy Nasdaq has fallen into correction territory already.

The fundamentals just aren't there

Analysts have warned that the recent run-up in stocks during the recovery phase couldn't go on indefinitely. Monetary policy would have to be tightened, and the government's massive spending programs would come to an end. That appears to be the situation we are in now, with the Build Back Better bill effectively dead in Congress and the Fed all but directly saying they will raise rates in March.

The thing about corrections, though, is that they simply mean a pull-back before the market springs forward again. As we will demonstrate shortly, in recent history, that often means a bounce off the 200-day SMA – but not always!

Is it confirmed?

Tug of war battles between bulls and bears are always happening but seem to take on extra importance at the 200 day average. Sometimes they lead to an extended bull market, others to a bear, history shows.

How can we tell from the price which way it might go?
A simple cross of the price below its moving average can lead to false breakdowns (the price makes a move lower which is quickly reversed). Confirmation is mandatory to determine whether the SPX's breakout is real or false.

Breakouts can be confirmed using:

• closing prices,
• filters,
• time, and
• volatility

Since we are talking about a daily average, daily candlesticks should be used, not intraday charts. Daily candles that break the 200-day MA and remain outside the breakout level for longer than two days is solid confirmation. At least one close below the low of the breakout candle offers additional strength to the bear market signal. Weekly bars closing below the 50-week average (roughly equivalent to the 200-day) have foretold some major breakdowns.

Looking back over the past four years, a drop below the 200 DMA has been a buy signal more frequently than a sell signal, but the two sell signals were big ones!

Source: Spreadex Trading Platform

Final words

At current levels, the daily chart of SPX does not show a ‘strong’ confirmed breakdown since there has been now move below the first candle that broke the 200 DMA. However, prices have remained below the 200-day average, hinting at limited demand to ‘buy the dip’. The weekly method shows the SPX bouncing off its 50-week average and no breakdown whatsoever (yet)