WASHINGTON. If you’ve already read our earlier column, you know we busied ourselves working our #Resistance metaphor to death. But what we’re subtly referring to, aside from dissing the Democrats’ current political asininity, is a key concept in the wonderful world of technical analysis. That’s the currently dominant investing system and philosophy that anyone in today’s wild stock market must have at least a passing familiarity with. So let’s talk about technical analysis and technical analysts today as an out-of-sequence part of our periodic Investing 101 series of educational articles.
Technical analysis and the wonderful world of charts
Many of today’s stock analysts pore over various charts illustrating the historical path of stocks and market averages over a given period. They use charts and date to predict and time promising investment decisions. The investing public identifies these individuals as technical analysts, or “chartists.”
Technical analysts or chartists interpret movements in stock and market average charts – technical analysis – to determine when it’s best to enter or exit a given investment. Earnings and sales figures don’t much bother technical analysts Their reading of the technical tealeaves tells them more, so they say, than traditional fundamental analysis.
That older methodology for determining a promising investment relies on traditional accounting standards – profit and loss (P&L) statements, sales, earnings, and price earnings (PE) ratios – to winnow down their stock recommendations.
Given how computerized our society has become since circa 1980, various forms of technical analysis have grown more popular with investors over the last 40 years or so. As a result, tealeaf readings by technical analysts often become self-fulfilling prophecies as more investors get on or off the train based on technical recommendations.
Moving averages, support and resistance
When it comes to averages, many, though not all technical analysts give great meaning to what they call “moving averages,” which they compute in a variety of ways, which we won’t bother with here. Moving averages are simply flat or wavy colored lines drawn on stock or market average charts that plot the general direction – up or down – that stocks or averages have taken over X period of time. They regard the past as prologue, more or less, and have determined over the years that stocks or averages tend to move along with the general direction of moving averages. Until they don’t.
Some technical analysts draw a straight line beneath those points in a chart where the stock tends to “bottom” during times of earnings trouble or other negative events. Ditto when these technical analysts draw similar straight lines above the “tops” of a stocks movements on the chart. These, they regard as lines of “support” and “resistance.” These analysts have noted, over time, that a given stock tends not to drop below its line of support. But it also has a tough time getting above its line of resistance.
You can also plot support and resistance in terms of a stock’s “moving average.” Depending on the technical analysts involved, these wavy lines are computed mathematically. The lines based on each type of moving average more or less trace the parameters of a stock’s movement over a measured interval of time.
Most technical analyses that we read give great significance to 20-, 50- and 200-day moving averages, particularly the latter. These more or less correspond to 20-, 50- and 200-day stock or market average “paths.” Once a stock or average decisively breaks up and through, say, its 200-day moving average, that wavy line becomes “support.” In other words, after that point, if the stock should decline, it generally won’t decline below its line of support, that 200-day moving average. (Until it does.)
Contrary-wise, if the stock or average tanks, cutting decisively through, say, its 200-day moving average and finally settling down at a much lower price level, the stock or average will tend to have a tough time moving back above that 200-day moving average. Thus, what analysts once regarded as a line of support now becomes a line of “resistance.” Each time a stock or average touches or slightly exceeds that 200-day moving average line of resistance, it tends to recoil, i.e., get sold off by investors who rely on those technical analysts.
Investopedia offers, perhaps, a slightly less eggheaded play-by-play. If you follow this link, you get the whole entry on the topic plus a nifty video. The video is less than 2 minutes long, and gives you a simple, useful view of how an investor might use technical analysis to find an investment idea.
“Support is a price level where a downtrend can be expected to pause due to a concentration of demand. As the price of a security drops, demand for the shares increases, thus forming the support line. Meanwhile, resistance zones arise due to a sell-off when prices increase.
“Once an area or “zone” of support or resistance has been identified, it provides valuable potential trade entry or exit points. This is because, as a price reaches a point of support or resistance, it will do one of two things – bounce back away from the support or resistance level, or violate the price level and continue in its direction – until it hits the next support or resistance level.
“Most forms of trades are based on the belief that support and resistance zones will not be broken.”
Support, resistance and the $SPX
Support and resistance. China aside, technical support and resistance levels are really what’s going on this week with Mr. Market. Although my own calculations have the $SPX already decisively breaking through my current “line of resistance” at around 2700, it seems most professional tech analysts have plotted their line of resistance at around 2800. Which is why we’re talking about this today.
So far, 2019’s Q1 mega-rally has proved so surprisingly strong that it’s gotten many stocks back to where they were before the Q4 2018 market disaster. So the charts tell technical investors that Mr. Market needs either to decline again, or simply mark time until Mr. Market can “digest” this year’s super-big bull move. Then, if the bullish analysts prove correct, the big 2019 rally and/or bull market will resume.
If not, we’re in a peck of trouble.
Fundamentalists v technicians
We follow this stuff because we have to. We’re “fundamentalist” investors ourselves, looking for value and not reading tealeaves. But technical analysis eventually came to dominate investing decisions. Machine-based trading programs also embrace technical, but also incorporate AI, stock momentum, and, alas, big headlines that can — and therefore do — move markets.
You ignore all this stuff at your peril today. Machines and many investors alike move in lock step. Investors and machines in particular base buy or sell decisions on moving average inflection points.
Hence, the current back-and-forth Hamleting behavior we’re seeing on Wall Street. China may still be a catalyst. But in the end, a decisive break by the S&P above its 2800 wall is what the bulls need to launch the 2019 rally Part II.
— Headline image: Stock chart showing levels of support (4,5,6, 7, and 8) and resistance (1, 2, and 3); levels of resistance tend to become levels of support and vice versa. Public domain image, description, via Wikipedia entry on Technical Analysis. Image modified to fit space requirements.