Sell in May and go away?

The marketplace is abuzz with the ideas like “the worst is over”, “markets will be fine by the end of the year”, “and it (from March lows) is a bear market rally”, “sell in May and go away”, “Wait; not this May: it is different this time” and the sound bites go on and on.

SPX daily


First let’s look at the daily chart of SPX (S&P 500) going back 10 years so that we can see the action in 2002 and 2003. The first oval in 2002 and 2003 is where SPX made a base and changed direction. The second oval is current price action.
We can see that in each oval is representing an area of consolidation. The market is trying to base.

SPX daily with price removed and 50, 200 SMA


Now let’s look at the same chart with price removed and showing 50 period (Green) and 200 period (Red) SMA (Simple Moving Average).

The direction of 50 SMA crossing 200 SMA is the direction of trend, i.e. up or down. The distance between the two averages is the momentum of the trend.

The first oval: Notice that during the steep decline of 2002, the 50 SMA is running away from the 200 SMA but during Nov 2002 the averages started coming nearer. Still, the trend had not reversed; the market was trying to find its bottom, 200 SMA was still declining. Finally in Apr 2003, 50 SMA again started moving up. This time 200 SMA slowed its decline and changed its slope upwards (May, June 2002).

The second oval: Currently, the distance between 50 and 200 sma is pretty wide. For the market to base and change the trend this distance needs to shrink. Thereafter 50 need to cross the 200 from below to signal the change in trend.

The crossover of 50 SMA and 200 SMA comes with a lag. In the daily chart it is a late signal that will come after market would already have bounced some distance from the bottom. But when you see it, you can be more certain that the trend has changed.

If one’s time horizon is not small (meaning one is not a day trader or a swing trader), one can indeed “sell in May and go away”. The market has more water to tread. Obviously, for time sensitive vehicles like nearer term options this signal by itself may not be appropriate.