It’s “NERDvember” again, which means it’s time to write educational articles and updates on the market that cater to a relatively small percentage of our readers (15-20% at most, I’m guessing). So why am I doing it again this year? Well, because different people have different interests, and the feedback we’ve been getting from our clients is:
1. Keep the articles shorter,
2. Use fewer charts, if any (1-2, at most), and
3. Write more about general financial planning topics and be less technical.
Keeping all this in mind – and the fact that more of the articles I write in the future will be less technical in nature – I’ll continue to dedicate the entire month of November to purely “nerdy” education. So let’s get on with it!
Two charts to share today…
The first is a type of chart that I see in some articles I read from time to time, as well as on social media (primarily Twitter). What you’re looking at is the longest bull (up) market in U.S. history in black, which lasted roughly 14 years between 1987 and 2000. Then, in blue, you’re looking at the current bull market, which just happens to be the 2nd-longest in history.
Typically, those who include these types of charts in their analysis draw conclusions or make predictions, suggesting that the market “should” continue upward, reflecting some resemblance of the past. Technical analysts like me call this “Chart Crime.” Why? Well, you have to answer this question – “What is this chart good for?”
The answer to this question can be paraphrased for my old-school music fans out there. As Edwin Starr once said, “Absolutely nothing.” In other words, the market doesn’t have to move with (or against) history. On one hand, as Mark Twain once said, “History doesn’t repeat itself, but it sure does rhyme.” On the other hand, the market will do whatever it wants to do at any given time. So, using historical charts and overlaying them with current charts is, most certainly, “Chart Crime!”
Alrighty – that was the easy lesson for the day. This next one is a little tougher, but stay with me and I promise to make this mess-of-a-chart below make sense!
There are three things I want you to learn from the chart and my explanation, below:
1. What support and resistance zones are,
2. What a “breakout” (or breakdown) is, and
3. A couple mini-lessons about trend and strength-of-trend.
Support and Resistance:
As a memory-jogger, try to remember first, that support always resides below your feet, “keeping an investment from falling,” while resistance is above your head, “keeping an investment from moving higher.”
Support exists because, whenever an investment falls to a certain price, buyers step in, which pushes prices back up again. The more buyers there are at a certain level, the more “support” there is.
Resistance exists for the exact opposite reason. Whenever an investment rises to a certain price, sellers step in and as they sell their shares of the investments they own, this pushes price back down again. Again, the more sellers there are at a certain level, the more “resistance” there is.
Breakouts and Breakdowns:
Whenever an investment manages to outlast the sellers at a point of overhead resistance, this is called a breakout. On the other hand, a “breakdown” would be the opposite – when there aren’t enough buyers left to push the investment up, sellers overwhelm the investment, causing an imbalance, which pushes the price down, below the floor of support.
Below, you can see how the S&P500 had a ceiling of potential resistance from the highs that took place in July, and then again at the September highs. As the market headed higher for the third time, there were enough buyers to exhaust the sellers, which lead to a breakout. Typically, I like to see breakouts (or breakdowns, for that matter) hold for 2-3 days before I consider them a “confirmed” breakout.
All that being said, using the example below, if this breakout were to fail in the coming weeks and we fell below this previous ceiling of resistance (which has now become a new level of support), there would be a lot of reason to start playing defense in our clients’ retirement portfolios. At least for now, the market looks just fine, however.
Trend and Strength-of-Trend:
Last lesson for today looks messier than it really is, but trust me, you’re about to learn about a really interesting tool.
What you’re looking at in the bottom-pane of the chart above is something called a “Directional Movement Indicator” or DMI (the red and blue lines), and ADX in black, which stands for “Average Directional Movement.” Have a lost any of you yet?! Stay with me!
DMI (red/blue) is based on the movement of the price movement of an investment and its momentum. When the blue line is above the red line, price momentum is up. When the red line is above the blue line, momentum is down.
ADX is where things can get a little confusing. ADX measures strength-of-trend:
– If it’s low = the current trend (whether it’s up or down) is weak
– If it’s high = the current trend (whether it’s up or down) is strong
– If it’s falling = the current trend (up or down) is weakening, and
– If it’s rising = the current trend (up or down) is strengthening.
So when you combine DMI with ADX, you can determine whether the trend is up or down, if momentum is up or down, and finally, how strong the current trend is.
When you observe the chart above, which is the current market as of Thursday’s close of business, the blue line is above the red line and rising (DMI), which means the trend is up, all while ADX is also rising, indicating that the positive trend is strengthening.
In conclusion, knowing where floors of potential support and ceilings of potential resistance lie – and understanding one of the many ways to identify the current market’s trend, one can better determine how much risk to take in their retirement portfolio at any given time. Never forget this key point… always invest with the trend, not against it!
If you have any questions, please feel to reach out to me, personally!
Till next time…
AdamCategories: Adam Koos, CFP®, CMT®, Market Commentary