New Year, New Stock Market?

By Brad Thomason, CPA


What goes up… apparently is not all that interested in continuing the trend for the moment.  All through 2013 I took a watch-and-be-careful stance in my writings about the stock market.  There were plenty of chances for the market to break down, but as each one got close to happening the market decided to resume its run.

So how about now?  Healthy pullback, or the early days of a sho-nuff reversal?

I’ll tell you some of the things the pros are likely looking at right now.  There is a maxim that says prior resistance becomes future support in a bull market (with the opposite true in that other kind of trend).  So when the market starts falling, the pros look for places where there might be something to arrest the fall.  The first place they look is for areas where the market had to make several attempts to move higher, i.e. resistance.

Support and resistance levels represent the places in the recent past where market participants “argued” over the real value of an asset.  They are also assumed to predict where the next such argument will take place.

A real world example makes this bit of theory clear:  If you went to the store and beer was selling for $1 a six pack you would buy a lot, and soon the store would raise prices.  The moment would soon pass, but not its memory.  The message you would carry forward with you is that beer is not likely to drop below a dollar.  And if it does, something really nutty must be going on.

So if you look at the Dow chart for the last year or so you see that during the period of May 2013 through September 2013 the market had a heck of a time getting and staying above 15,500.  Those peaks are understood to be the resistance points, and when prices finally broke through in November it was seen as a bullish sign.  Note too that when the market retraced a bit in December, it fell only to the 15,500 level and started going back up again.  The prior resistance had become the current support.

You see where I’m headed right?  During the past few sessions, as the price hit 15,500 and kept dropping you had long-side investors everywhere saying, “Phooey!  I wish it hadn’t done that.”  Because with the support level breached, it now starts to get worrisome when trying to figure out how-low-will-it-go?

It should be said that the market is under no obligation to drop to a certain level before it is allowed to reverse course.  No such force exists.  But it is also good to remember that the market has a memory: because the market is nothing more than a bunch of humans, many of whom spend an awful lot of time tracking what happened before.  As a result, more often than not, looking at support and resistance levels is at least not a waste of time.

So where is the next support level?  Look to that same May to September period, though not at the tops of the saw-teeth, but the bottoms.  On a fairly consistent basis, throughout that period, when the market got down around 14,700, the buyers said “no more.”  Beer hit $1, so to speak, and they all started piling back in.  Price ticked back up.  Absent a good reason otherwise, that would be a reasonable place to expect a turn around.  Though again, the market can do what it wants and the right combination of news stories could spin it around where it sits right now.

What if 14,700 doesn’t hold?  Well at that point I think we would say that there is a full-on correction, maybe even a reversal to a bear market.  If that is the case, investors will be asking the age-old question, “Why the hell didn’t I sell at the top?”

Moments like these highlight why investing without a plan can be a problem.  If you are satisfied that you are going to hold stocks for the next 20 years no matter what, then you probably shouldn’t be paying much attention to any of this in the first place.  Conversely, if you just want off the roller-coaster, why are you still on it?  For that matter, why did you get on it to begin with?  This is what the stock market does, after all.

The 2014 stock market has already followed through on more potential set-ups to go lower than I remember it doing in all of 2013.  I will reiterate my earlier advice to think about what it might take for you to decide that the fun is off the menu for awhile; then watch very carefully – because you may get what you are looking for real soon.

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