The future is very hard to predict, which is why we focus on identifying the current trend and reacting accordingly. The recent expectation breakers on the S&P 500 suggested potential trend changes rather than normal deviations. Those are important and they can be positive or negative.
Negative Expectation Breakers Are Not To Be Ignored
The challenge with following trends is they don't happen in straight lines. You might be able to identify the trend with a single line but you expect some variation from the average. Sometimes a variation is more pronounced than others. That can make a normal pullback in the S&P 500 raise a question: Is this a normal deviation from the mean or a change in trend?
We favor using the SPDR S&P 500 exchange traded fund to represent the action of the S&P 500. This column previously addressed an expectation breaker in August.
To recap, a minor 5% pullback in the S&P 500 crossed below the 50-day moving average line (1). After a weak bounce, the index triggered a follow-through day a few days later signaling a change in the trend (2). The expectation is that if the trend truly changed, you will quickly get momentum in the direction of the new trend.
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That's not what happened. The next day was a big outside day closing near the lows (3). It was a negative expectation breaker. We went from 91% invested down to 21% by the close. If we hadn't done aggressive selling then we would have certainly taken a larger drawdown as the downtrend took another sharp leg down (4).
Change As New Data Comes In
Since we were barely invested at the Aug. 5 bottom, we were unaffected by the panic selling of the morning. The question then becomes, when to get back in? On Aug. 13, we got another follow-through day in the S&P 500 (5). We steadily increased our exposure, including a position in the ProShares Ultra S&P 500 ETF on SwingTrader. The ETF adds leverage by doubling the move of the S&P 500.
As the index pushed ahead, we saw steady gains. It culminated in another positive signal when the S&P 500 triggered a power trend rule from our Market School program (6). That signals a new trend is well established and our focus shifts to holding winners and getting more money into them. Instead we got another negative expectation breaker (7). We cut our exposure in half immediately and continued lightening through the end of the week as the S&P 500 fell further (8). Interestingly, it nearly matched the level reached on the first breach of the 50-day line (1).
Why This S&P 500 Expectation Breaker Was Different
That line around 540 became a battleground. If the bears were truly in control, the expectation is that level wouldn't hold. Instead we got a positive expectation breaker (9).
When the battle lines were tested, not only did they hold but the bulls advanced the S&P 500 past the Sept. 6 high and approached the Aug. 1 high (3). So far, that advance is continuing rather than being reversed.
Now the battle lines have been redrawn in favor of the bulls. We increased back to full exposure on SwingTrader by repurchasing our leveraged S&P 500 ETF. It's not always easy keeping up with market gyrations but recognizing early signals with expectation breakers can start your momentum before a trend is too obvious and too far to profit.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
