Recency bias can be an important, and often misleading, factor when it comes to forecasting performance in the financial markets.
For example, after a strong year of stock performance in 2021, most market pundits predicted another strong year in 2022. But those predictions didn’t come to fruition.
This year, most pundits were hedging their bets for 2023—suggesting that market performance could be weak once again. The reality is, most predictions in the financial markets aren’t worth the paper they’re written on. That doesn’t mean every single one is wrong, just the vast majority.
So despite all the early negativity from pundits, the financial markets have started 2023 on strong footing, with the stock, the bond, and several key commodities markets all gaining ground during the first month of the year.
For example, the S&P 500 and bond market are both up 5% this year. Moreover, two key commodities markets—oil and gold—have rallied in strong fashion to start the new year.
Taken altogether, early activity in the 2023 financial markets suggests that bullish optimism hasn’t been vanquished, despite the market’s struggles in 2022. That reality is underscored by the fact that the S&P 500 is on the cusp of marking a so-called “golden cross.”
A golden cross occurs when a security’s short-term moving average breaks above its long-term average—a development that’s often interpreted as a bullish breakout. If the golden cross is accompanied by stronger-than-average trading volume, that can be a secondary signal that bullish sentiment has taken hold.
The golden cross is traditionally viewed as a bullish trading signal by practitioners of the technical analysis trading philosophy. The signal is observed using moving averages—particularly the 50-day and 200-day. A golden cross occurs when the 50-day moving average rises above the 200-day moving average.
Moving averages—couched within the “technical analysis” philosophy of investing/trading—are viewed as helpful in analyzing longer-term trends in a single stock, a stock index, or pretty much any other investable/tradable asset that can be viewed on a price chart.
In basic terms, a simple moving average (SMA) calculates an asset’s average closing price over a set window of time. SMAs typically appear as a line on a price chart, and can help investors and traders identify emerging trends.
The 200-day moving average in the S&P 500 is one of the most-followed SMAs, and is calculated by adding the closing prices of the last 200 sessions for the S&P 500, and dividing that sum by 200, and repeating the next day.
At present, the 50-day moving average in the S&P 500 is 3,940, while the 200-day moving average is 3,959. This data indicates that a golden cross could emerge at some point in the very near future.
If a golden cross does materialize, it would be the first time in the S&P 500 since July 2020. After that golden cross, the stock market surged more than 50%. That said, the golden cross signal is no guarantee of future performance.
According to data compiled by TheChartReport.com, the golden cross has been an accurate predictor of positive future performance in roughly 64% of historical instances. That’s based on an analysis of 81 previous golden crosses in the Dow Jones Industrial Average, going back to 1896.
The emergence of a full-blown golden cross pattern could therefore generate additional bullish momentum in the stock market. That positive sentiment could spill over into other sectors of the financial markets, as well.
In addition to the golden cross pattern, investors and traders seeking to track technical indicators in the market can also monitor the Relative Strength Indicator (RSI).
Using the relative strength indicator (RSI)
Similar to moving averages, the relative strength indicator, or RSI, hails from the technical analysis discipline, and is viewed as an indicator of momentum. RSI essentially measures the speed and momentum of a given security’s recent price movement.
RSI is expressed as a number between 0 and 100, and is typically displayed on a line graph. Generally, RSI goes up as the number and magnitude of “up” days increase, and RSI goes down when the number and magnitude of “down” days increase.
Traditionally, a security with an RSI above 70 is considered overbought, while a security with an RSI below 30 is considered oversold. Some market participants use these levels as signals to assess whether a security is primed for a potential reversal in trend.
For example, when the RSI is below 30, some might view oversold conditions as an attractive entry point for a bullish reversal. On the other hand, an RSI above 70 might indicate the security is due for a bearish reversal, as illustrated below.
The current RSI for the S&P 500 is roughly 59, which means it hasn’t yet reached an extreme. An RSI of between 45 and 55 might be thought of as between trends, or as possessing no discernible trend.
In this regard, the current RSI of the S&P 500 doesn’t provide definitive guidance. However, that could change at any time, which is why investors and traders may want to monitor the RSI of the major market indices going forward.
If the RSI of the S&P 500 swings toward one extreme or the other, that could provide further insight into where the stock market may be headed next.
To learn more about reading technical indicators in the market, check out Trading Charts with Tim Knight on the tastylive network, weekdays from 2:15 p.m. to 2:30 p.m. CDT.
Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastylive or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to email@example.com.