This blog post talks about one of the big picture features available on our website, the Above 50 EMA Index.
What is the use of the Index and how to interpret its signals?
This index tracks the number of stocks that are trading above their 50 Day Exponential Moving Average.
Why 50 days and not more or less?
50 days represents 10 weeks of market activity, which forms almost 20% of the year. It is a shorter term strength guidance for a stock. So, if a stock is trading above 50EMA it is termed to be bullish and below the EMA the stock is termed to be bearish.
How to use this Index?
When the index moves above 75 market is likely to turn down and when the same goes below 25, the market is likely to turn up. When such instances come up, traders can look to identify stocks that have made a base at the bottom for going long or stocks that are forming weakness at the overvalued zone to go short.
When the index is at 75, investors can use the signal to exit some of their long term holdings which are finding it tough to move up. They can even be good stocks, which are facing resistance in price moves on the short term. By selling and buying back when they get a little cheaper, you get an opportunity to reduce the weakness in your investment portfolio when there is a correction in the markets.
What is the logic behind this thought of 75 & 25?
If the index moves above 75, it means 75% of the stocks in the market are bullish. At the same time, not all of them are at the same levels of bullishness. Some of them would have up even when the market was down while some would been early risers, which were the ones that ticked the index to move up. These old timers and early birds would have completed their journey when the index reaches above 75.
When most of the market is bullish, some early investors and institutions who are holding big positions running for a long period would want to book profits. Some of the stocks that went up due to fundamental strength will begin to slow down on their growth, triggering a downward price move. At the same time some stocks would have run up on expectations of big results where the companies would not have met the expectations and have triggered a selloff.
All of the above happens at the top and thereby qualifies as a selling level when the index moves above 75.
The same happens with buying when the index goes below 25. As more and more stocks turn down, those that began the downward move would have completed their bottom and base formation. After drop in prices, company’s earning would look attractive on the stocks valuation. Turn around will trigger institutional buying. Along with this the common adage,’ when there is fear in the market, go ahead and buy, you will make the biggest gains’.
Many such instances of turn around from the bottom can be seen in the chart. July 2019, Oct 2019, Feb 2019 & Mid-May 2019. Now it is again below 25 on 12thJuly 2019. Exactly 1 year from where it also had a similar pattern.
It is time now to look for stocks that have bottomed on their prices. Stocks having bullish divergence on the MACD or histogram on the daily charts. Stocks that are showing strong bullish patterns in the weekly chart and come down in price to reach value zone. These are stocks that will have big rally on a turnaround.
One can easily find a minimum of 5 stocks with the above qualifies and most of them end up giving above 3 times the risk exposed on the positions.
The Above 50 EMA index chart is published on our website with weekly updates. It has been populated on Weekly updates to have a smoother chart, else it will be more crowded if it is populated with daily data.