A look at indices

A case in point that can stand for others would be the S&P 500. As we can see in the chart below, the index tends to rally from January into June (with some indecision in January/February), before consolidating during the summer, then dipping into October. From October the path is clear for a rally. It is important to note that this is the average performance for a 20-year period, so some years do not follow this pattern (notably, for our purposes, 2013, which simply saw a steady rally with modest retracements throughout the year and no summer weakness).

Thus, history suggests that markets may struggle to make much progress over the summer, and could be vulnerable to a short-term drop in the late summer/early Autumn period. This is only a guide, however, and the idea of trend following/dip buying requires an approach that takes other factors into consideration when ‘buying the dip.’

Another indicator to consider would be looking at the percentage of stocks above key moving averages. Like many indicators, especially in a bull market, it is better at spotting potential bottoms rather than potential tops. Two examples below, one from the French CAC 40 and one from the Nasdaq 100, will illustrate the point. 

We can see that the percentage of index members above their 50-day simple moving average (SMA), chosen because it is a useful balance between short-term and long-term averages, and gives fewer false signals than a shorter period SMA, is now at levels consistent with bounces. On the face of it, it shows that a significant proportion of stocks have been declining, and thus is apparently a sign of weakness. But in a bull market uptrend, such as we are seeing now, dips are there to be bought. Previous dips such as that in April for the CAC 40, and in April and May for the Nasdaq 100, were followed by rallies. It is much better, from a risk management perspective, to buy a retracement in a trend rather than just jump in without looking at the underlying state of the market.

Traders should wait for the market to come to them, rather than chasing it. Then, with proper risk management in place, they can take advantage of periods of apparent weakness as a chance to hop on board existing trends. While seasonality suggests a summer pause is upon us, it is clear that some indices have gone through a period of weakness that, if history is any guide, could be followed by a rally.