$SPX Distance Above The 200-Day Moving Average (Preview)

By Lawrence G. McMillan

Whenever the market has an extended bull run, such as it's having now, it begins to put a lot of distance between the current value of $SPX and its 200-day Moving Average. Inevitably, some "analyst" posts the fact that "$SPX is x% above its 200-day Moving Average" and then alleges that disaster is at hand. Usually, a deluge of similar analyses follows. Those types of statements are usually wrong, or at least misleading. Two things that are rarely explored in these articles are: 1) when is disaster going to be at hand, and 2) is percent really the measure we want to use, rather than standard deviations?

Standard deviations are based on volatility, and that is a far better measure of how "overbought" the market is. For example, in late January 2018, right before a very nasty pullback in February, $SPX was 11% above its moving average. That is well above average, but nothing truly outstanding. Meanwhile, at that same time, the 200-day Historical Volatility of $SPX had fallen to nearly 6%. So that meant that $SPX was an historic 35σ above its 200-day moving average (using the 200-day HV as the volatility input). Within a week, a nearly 8% drop in $SPX occurred in just four trading days.

Obviously, $SPX will some day once again pull back to, or nearly to, the 200-day Moving Average, but can we establish a system that will allow us to make money shorting into an overbought market?

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