Not so fast.
During a phone conversation yesterday, questions surfaced whether or not the huge increase in the market on Wednesday meant the stock market was once again going into “rally mode”. From my perspective, this is not necessarily going to be the case. The gentleman I was speaking to wondered why I am not more bullish about the market moving forward. I just thought that I’d share my response with the rest of you by providing some historical data.
It’s important to let you know that history doesn’t always repeat itself. Just because something occurred at some point in the past doesn’t mean it will necessarily occur again. It’s also important to point out that my opinion about the future direction of the markets may be wrong. However, based on a review of the historical evidence, I strongly believe individual investors should remain cautious at the very least.
The Dow Jones Industrial Average rallied 2.54% on Wednesday and the S&P 500 rallied 2.94%, certainly big days. But given the context in which these rallies occurred, this might serve as a red flag, a warning of a coming decline.
Let’s begin with some context.
As a reminder, technical analysis is a method of evaluating investments and market activity by relying on historical data such as charts of price and volume. Technical analysts use this data to forecast the future direction of an investment. Although historical data is not always a reliable indicator of future performance, technical analysts believe the study of past market trends leads to trading opportunities.
Recently, major US stock market indices like the S&P 500, the Dow Jones Industrial Average, and the NASDAQ Composite have formed a top head and shoulders formation #1. Historically, this formation has often preceded market declines.
In early July, the 50 day moving averages #2 in these indexes passed under their 200 day moving averages on the charts, an infrequent occurrence and one that has been reasonably accurate in predicting previous declines.
While no one indicator is accurate all the time nor is it necessarily wise to make investment decisions based on a small number of indicators, a head and shoulders top forming at about the same time as the 50 day moving average passes under the 200 day moving average, should serve as a cautionary flag at the very least in my opinion.
But let’s take it a step further by looking at what we’ve seen of late in the market and then compare it to a couple of historical time frames. The current market volatility resembles some of the market activity that has preceded past market declines.
Recently, we’ve had several panic buying and panic selling days. Panic buying days are typically defined as a dramatic up day in the markets driven by a rapid increase in buy orders prompted by rising share prices. Prices rise so rapidly that investors ‘jump in’ and buy for fear of missing out or being left behind. Panic selling days are the polar opposite of panic buying days.
In my opinion, out of the last 90 trading days through September 1st, 27 of these days were panic buying or panic selling days. Wednesday was a panic buying day, Monday, August 30 was a panic selling day, and Friday, August 27 was a panic buying day making 3 of the last 4 trading days (as of Wednesday, September 1) panic buying or panic selling days.
Historically speaking this is interesting.
Prior to the 1987 stock market crash from October 14 to October 19, a similar pattern occurred:
· On August 31, 1987 stocks rose almost 1%
· The next day, September 1, 1987, the Dow Jones Industrial Average fell almost 2%
· September 10 and 11, 1987 saw the Dow Industrials rise 2.31%
· On September 15, 1987, the DJIA fell 1.78%
· September 22, 1987 the Dow rose sharply, by 3.01%
· On October 1, 1987 the DJIA again rose, this time by 1.65%
· On October 6, 1987, the DJIA dropped by 3.46%
· The day before the crash started, the Dow Jones Industrial Average rose 1.49%
· Then, the crash occurred, and from October 14 to October 19, 1987 the DJIA dropped 30.6%
Prior to the 2008 market decline, we also witnessed similar volatility. From the Fall of 2008 through March of 2009, stocks fell about 45%. Here are the notable trading days preceding that decline. All trading days noted below are the point increases or point declines of the Dow Jones Industrials #3 and occurred during 2008:
· August 28 +253.95
· September 8 +289.78
· September 11 +164.79
· September 15 -504.48
· September 18 +410.03
· September 19 +368.75
· September 29 -777.68
By the end of October 2008, stocks were down about another 30% and before the decline ceased in early 2009, stocks declined another 15%.
So what does all this mean?
Is a decline imminent?
As I stated, no technical indicator is effective 100% of the time.
My opinion?
Caution is the order of the day, based upon a review of some historical data.
Securities offered through USA Advanced Planners (Member FINRA/SIPC). Advisory services offered through USA Wealth Management. USA Advanced Planners and USA Wealth Management are affiliated companies. The opinions expressed herein are those of the writer and not necessarily that of the above noted affiliated companies. The information and views contained in this entry are not necessarily that of the above noted companies. Any information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed.
This entry may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be considered a guarantee. Prior to making any investment decision, the services of an appropriate professionals should be obtained in order to understand the risks, costs, and benefits associated with a particular investment.
#1) A Head and Shoulders Top Formation Is a technical analysis term used to describe a chart formation in which a stock’s price: (1) rises to a peak and then subsequently declines, (2) then rises above the former peak and again declines, and (3) finally rises again, but not to the second peak, and declines once more. The first and third peaks are the shoulders and the second peak is the head. The “head-and-shoulders” pattern is believed to be one of the most reliable trend-reversal patterns
#2) Moving Averages is a technical analysis term meaning the average price of a security over a specified time period.
#3) Dow Jones Industrial Average is the best-known US index of stocks. A price-weighted average of 30 actively traded, well-established companies’ shares. The Dow, as it is called, is a barometer of how shares of the largest US companies are performing
