A Short Technical Analysis Primer
Feb 17, 2009
Posted by Jody Eisenman | Filed under Uncategorized
Technical analysis of stock prices (or any security such as commodities or bonds) is very popular today. Simply put, this analysis assumes that past prices can predict the future. Pure technical factors tend to ignore fundamentals (such as earnings, growth rates, etc.) and believe that “the tape tells everything”. In other words, all you need to know in order to trade a stock is to look at the past history via charts. I must admit that I felt this methodology to be some sort of junk science for many years. However, I know now to give it more credence (although I cannot ignore fundamentals) simply because it works quite often. Now, I’m not really sure if it works because the past can foretell the future, or because enough traders believe that it does so that it becomes a self fulfilling prophecy.
For example, lets say stock X has traded in a range of between 20 and 24 for past 2 months. Three times the stock has traded down to 20, and each time it “bounced” and went higher. One would then consider 20 to be a bottom (when it happens three times within a relatively short period, it’s called a “triple bottom”). Therefore, one way of trading stock X might be to buy it just above 20, and put a stop loss just below 20, say at 19.80. You are basically relying on the past that stock X will once again trade higher. If it breaks 20 to the downside, this would be very negative for the stock, and it might trade down to its’ next support level ( the next price where buying seems to be). Of course, there’s much more to this, but I just want to give readers a rudimentary understanding.
Now, relating this to the current market. If you look at a chart of the S and P 500, you will see that the index closed at around 826 last week. You will also see that for the past 6 weeks, the index has traded down to the 800-810 area and then “bounced” off it and traded higher. On Thursday, it looked like we were going to break through to the downside, but then Obama announced a new mortgage initiative, and the market rallied. From a technical standpoint, I view this level to be somewhat significant. If we were to close below it, it’s hard to tell how low we could drop. The market made a low of 741 in November, but there is no real level of support (meaning sustained buying interest) for at least a couple of hundred more points. Now, I’m not necessarily saying that this would happen, but we could drop pretty hard and fast if we break this support level. What seems to be more disheartening is that the markets’ reaction to Geithners’ bank plan and Obamas’ stimulus plan much the same it reacted to Paulson: with skepticism. Therefore, although there are always trading opportunities, I remain cautious on the overall market even at these levels.
February 18th, 2009 at 10:43 pm
I’m compelled to agree with you. What I saw and commented on in a previous post was unsubstantiated, and further caution will be necessary in our current market conditions.