The S&P 500 Index is the benchmark index for the U.S. stock markets, and for good reason. The muscular S&P 500 is home to the 500 largest companies in the U.S. by market-cap. (Market capitalization = price of a single share of stock x number of shares outstanding.) Moreover, this benchmark index represents the full spectrum of sectors in our economy. Wise traders and active investors watch its “mood and manner” to help predict in which direction the stock market is headed next.
But here’s the biggest reason I keep one eye on the S&P 500: During bull markets, three out of five stocks will follow the index higher. In bear markets, four out of five stocks will follow the benchmark lower. That’s important knowledge in helping me plan risk management for my portfolio.
We especially benefit from knowing whether the S&P 500 is traveling in an uptrend (bull market), downtrend (bear market), or horizontal range (swiveling up and down within a price channel).
For novice investors, here’s the definition of an uptrend and downtrend on a price chart:
An uptrend takes place when price moves up over time, creating a series of higher lows and higher highs.
A downtrend drives price down in a series of lower highs and lower lows.
When we see the S&P 500 climbing in a strong uptrend (bull market), we typically add strong stocks or other assets to our portfolios. When the benchmark gets cranky, and sinks into downtrends (bear market), we may decide to pocket a portion of our profits, raise our protective stops, and/or move to stocks that reside in defensive sectors (e.g., staples, utilities, telecom, and healthcare).
Now, we know it’s smart to monitor the current trend of the S&P 500 Index. But we’re all busy with our daily lives. So, the question is, “What is the fastest and easiest way to observe the index?” My favorite method is to check a monthly line chart of the index.
First, I like line charts because at a quick glance, it can tell us what we need to know in a New York minute. A line chart is plotted by connecting the closing price of the given time frame. For example, on a daily chart, a line connects each day’s closing price (for whatever asset you are analyzing) in a single line. On a weekly chart, the line connects each Friday’s closing price. And on a monthly chart, the line connects the last day of each month’s closing price.
Okay, that’s the “fast” part. Here’s the “easy”—but very important—part. You can look at a line chart and clearly see whether the S&P 500 Index, or any other index, is trending higher or lower, whether it’s in a bull market, or a bear market.
Further, when I add a 12-month moving average to the monthly chart of the S&P 500, I have an up-to-date perspective of the market’s current disposition.
Below you will see is a monthly line chart of the S&P 500 Index stretching from 1996 to the present date (black line). Also plotted on this chart is the 12-month simple moving average (blue line).
Chart Courtesy RealTick®
Note the uptrends/bull markets that took place from 1996 to 2000, from 2003 to 2007. Now, check out the brawny, beefy uptrend we’ve enjoyed for most of the time period between 2009 and the present (2011 was volatile). Next, note that when price (black line) falls below the blue line (12-month MA), the market is weak. And when the moving average, peaks and then rolls to the downside (2001 and 2008), it has been a great time to grab at least partial profits and become defensive.
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When will our current uptrend end? That’s up to the market. On our monthly chart, the S&P 500 is trading in a range between 1900 and 2070-2100. The index is deciding whether it is resilient enough to break higher (low interest rates could fuel that move), or give up and slide south. If it dives to close below 1870, I will get more defensive. (The 12-month MA will have rolled down by then.)
Whatever happens, continue to check in with the S&P 500 Index and its price trend. That way, you will stay on top of the market and ahead of the game.
Keep green on your screen!
Toni Turner is the President of TrendStar Group, LLC, is an accomplished technical analyst as well as a popular educator and sought-after speaker in the financial arena.
She is also the author of best-selling books: A Beginner’s Guide to Short-Term Trading, Short-Term Trading in the New Stock Market and Invest to Win: Earn and Keep Profits Bull and Bear Markets With the GainsMaster Approach, co-authored with Gordon Scott, CMT.