Put the state of the economy, the subprime issues, and the real estate market aside and let’s look at the market from a pure technical standpoint. I know that some people equate technical analysis with that of voodoo, but it may shed some light on where we’re headed. If you aren’t familiar with technical analysis, it is basically the practice of studying historical charts to identify patterns and trends in an effort to predict future results.
Support and Resistance
One of the most common technical signals are those of support and resistance. When a stock or index seems to bottom out along an imaginary trend line or other technical indicator, but not drop below it, that is seen as support. Resistance is just the opposite. When a stock or index seems to be hitting an imaginary ceiling and can’t go any higher, that is resistance.
What is important here is that when a stock has been struggling with a level of resistance and finally breaks through, it is expected to trend higher since there is no more resistance. And then the resistance item now becomes support. The same goes for when a stock falls through support. Once it drops below that point it has nothing to support the price and it is expected to continue to fall, and that previous support line is now the resistance line.
Why This May Be Important
Here is a chart of the Dow Jones Industrials Average covering the last year. On the chart, you will find two moving averages, the 20-day and 200-day moving average in blue and red respectively. These are two of the most common and regularly correspond to support and resistance.
You can see that using the shorter term moving average in blue, it followed it quite closely until it dropped through it in late February. From there it took a good month and testing it again as resistance before it broke through. Once it did, it continued to climb until late June, where it again bounced off of it as support, never really falling through until late July.
From that drop in July it tried to break that resistance a few times, but was never able to succeed, and it has continued to plummet for a couple weeks. Even more importantly, today the DJIA broke down and fell below the long-standing 200-day moving average, or the red line. It hasn’t done that since June and July of 2006, and the Dow was priced at 10,500 at the time.
Here is a more zoomed in look at what we’re dealing with today that can better illustrate the latest support and resistance events:
Should We Be Worried?
Does this mean that the Dow is going to plummet another 1,000+ points? Not at all. Today’s break in support could be completely reversed tomorrow, technical analysis can’t predict that. What is important to consider is that traders are aware of these technical issues and it can influence whether they are buying or selling, which can almost turn into a self-fulfilling prophecy. And also keep in mind that these are observations based on an index, or a collection of individual companies. It is harder to make technical predictions with an index, but if history is a guide, it may point to a possible trend regardless.
What Should You Do With Your Investments?
Nothing. Well, if you have a properly asset allocated portfolio, you really shouldn’t worry too much. If your investing time horizon is 15-30 years away, this is but a tiny blip on the screen. It is amazing how people will almost completely forget almost three years of double digit returns, yet as soon as their portfolio drops 5-6% in a short amount of time they think we’re headed for a depression and will lose all their money. Stay the course, and over time you’ll see that a few sharp declines in the market mean very little over the long term, especially if you are regularly investing every week or two weeks via systematic contributions.
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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.