Reduce Holdings as S&P 500 ETF Tests Its 200-Day Moving Average

The SPDR S&P 500 ETF (SPY) is referred to as "Spiders" by active traders and investors. Spiders declined by 20.4% from its all-time intraday high of $293.94 set on Sept. 21 to its Dec. 26 low of $233.76, marking the bear market.

The ETF closed Monday, Feb. 11, at $270.62, up 8.3% so far in 2019 and up 15.8% since trading as low as $233.76 on Dec. 26. This is a nice bear market rally, but with the ETF below a "death cross," it could be time to reduce holdings as Spiders tests its 200-day simple moving average, now at $274.08.

The accelerating decline into the Dec. 26 low was fueled by forced selling, not panic selling. FINRA reported that margin debt declined significantly in the fourth quarter. My eyeball estimate is that investors had to raise $50 billion to $60 billion in the fourth quarter to meet margin calls.

When Spiders traded as low as $233.76 on Dec. 26, the ETF turned on a dime. The main reason to buy on Dec. 26 was that the low was a test of the 200-week simple moving average, or "reversion to the mean," then at $234.71. This proved to be the correct call, as Dec. 26 was a classic "key reversal." Whenever a ticker sets a cycle low and then closes above the prior day's high, a tradeable rally follows. The Dec. 26 close of $246.18 was well above the Dec. 24 high of $240.83.

My first target in 2019 was my semiannual risky level of $266.14, which became a magnet on Jan. 30 on the dovish commentary that followed the FOMC meeting that day. Since this date, most Fed watchers are debating as to what Fed policy is.

I have been following the Federal Reserve since 1972, and here's my take. The Federal Reserve is using its balance sheet as its primary tool for monetary policy. The FOMC tightened monetary policy in January without raising rates. As of Feb. 6, the balance sheet was marked at $4.026 trillion, down $474 billion since the unwinding of the balance sheet began in October 2017. The balance sheet totaled $4.5 trillion as the great unwind began. The total unwinding in January was $32 billion, assuming the $14 billion reduction was due to maturing Treasuries on Jan. 31.

My call for the FOMC: I believe that the Federal Reserve will keep the federal funds rate at 2.25% to 2.50% as its revised "normal." The Fed balance sheet will become a primary monetary policy tool as the unwinding continues, but in the longer term, the Fed could increase the balance sheet without using quantitative easing measures.

The daily chart for SPY

The bear market decline began after Spiders set its all-time intraday high of $293.94 on Sept. 20, 2018. As the ETF declined, a "death cross" formed on Dec. 7, when the 50-day simple moving average declined below the 200-day simple moving average, indicating that lower prices would follow. This tracked the ETF to its Dec. 26 low of $233.76 and the "key reversal" day that confirmed a tradeable bear market rally. When under a "death cross," the strategy is to reduce holdings on strength to the 200-day SMA, now at $274.08.

The close of $249.92 on Dec. 31 resulted in three horizontal lines. My semiannual pivot is $266.14, with my annual and quarterly risky levels at $285.86 and $292.16, respectively. The close of $269.93 on Jan. 31 resulted in the horizontal line at $277.88, which is my risky level for February. This week's value level is $260.22. The Spiders ETF popped above its semiannual pivot at $266.14 on Jan. 30 following the dovish news from the FOMC meeting.

The weekly chart for SPY

The weekly chart for Spiders has been positive since the week of Jan. 18, and the ETF is above its five-week modified moving average at $266.6. SPY is now well above its 200-week simple moving average, or "reversion to the mean," at $236.74 after this average held at $234.71 as a buying opportunity during the week of Dec. 28. The 12 x 3 x 3 weekly slow stochastic reading is projected to end this week rising to 67.41, up from 60.49 on Feb. 8.

Trading Strategy: Now that you reduced holdings by booking profits at the 200-day simple moving average at $274.08, here's your updated strategy. Buy SPY on weakness to my semiannual pivot at $266.14 and to this week's value level at $260.22, and reduce holdings on strength to my monthly, annual and quarterly risky levels at $277.88, $285.86 and $292.16, respectively.

Disclosure: The author has no positions in any securities mentioned and no plans to initiate any positions within the next 72 hours.