The Dow Signals a Market Top


I don’t typically use charting because I tend to find that it tells you where you are but not where you are going.  For example, if you’re in an uptrend (a common charting term meaning basically a stock or market is making higher highs), there is nothing to stop the market from starting into a down trend in the next week.  By the time the market has done all is necessary to signal a down trend, however, the market will have already declined so much that you really can’t take advantage of it.  It will have already lost a large amount of value.

It is important to understand a bit of charting, however, because other people use it and it may affect their behavior, and therefore the behaviour of the whole market for short periods of time.

A chart of the Dow can be found here:

http://finance.yahoo.com/q/bc?s=%5EDJI&t=1y&l=on&z=l&q=c&c=

Today the Dow declined more than 1% – a fairly significant decline.  Note on the chart that it had not yet reached its previous high.  The fact that it is starting into a decline now before setting a new high is a classic “topping” pattern in charting.  In theory the idea is that prices tried to rise but the market ran out of people who were willing to pay more for the shares.  In order to sell shares, sellers had to reduce the amount they were willing to take for them to find buyers.  This means that the price began to decline.  Now that it failed to reach the previous high, it will be difficult for the market to move past that previous high.  This is because people will see that it topped there before and will therefore be reluctant to pay more than the previous high because they’re afraid no one will be there to  pay them a greater price.  This is called a “ceiling.”  To draw a common example, think of a year ago when gas prices went to around $4.00 per gallon and then declined.  As they are rising again now, you would consider $4 per gallon to be very expensive and about as high as prices will go.  You therefore probably wouldn’t decide to load up on gas at $4, hoping to sell some to your neighbors for $4.50.

The other thing to notice is that the last time it was in decline, it bottomed and spent a considerable amount of time around 11,000.   Chartists would call this a “floor”.   Because people consider this price “cheap,” people are likely to start buying again if the market hits that level.  Again with the gasoline analogy, because people haven’t seen gas below about $2.30 per gallon in a while, if gas fell from the current levels to that point, people would probably consider it cheap and decide to take more road trips.  Note that this is the case even though gas is still more than 100% above the price it was just a few years ago.

 What this means for followers of this blog is that if you have some cash sitting around and have been looking for a good time to load up on more shares, if the market falls to around 11,000 it might be a good time to load up on some of your favorites.  Note that you aren’t trying to time the market, expecting the market to turn immediately after you buy the shares.  You are still making a long-term buy (because investing long-term is so much easier than speculating short-term.  You’re just taking advantage of market psychology to pick an entry point.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.