This is where the power of technical analysis comes in. Asset prices are leading indicators of fundamental information. And, in times like this, where future earnings, etc. are incredibly uncertain, you can use the real-time information provided by markets to guide you.
How should we view Friday's market activity? Support at 8,000 (going back several years) for the Dow-Jones ($INDU) held. More importantly, while the market fell sharply at the open it then recovered quickly for a wild ride. The following chart from StockC
harts.com will help you see this (click on it to enlarge). This shows the last two weeks of market data for the Dow-Jones.First, look at the bar from eight days ago. It looks like a cross. In candlestick analysis, this is referred to as a "doji," which signifies indecisiveness - the bulls and bears fought a battle that nobody won. Note how short the bar is -- the gap between high and low was very small. Both features point to the possibility of a momentum reversal. Now go to the next day. Still a short bar, but the market closed near the low of the day, and close was below open. Not good for the bulls! The next day is even worse for the bulls: close at the day's low (near very short-term support) and an upward tail (undefended territory).
Now let's focus on the last two days, after apparent support (around 10,300) began to become a distant memory. The bars got much higher, so the daily battle of bulls and bears was intensifying. For Thursday, close was at the day's low. Ugh! For Friday, there was a large sell-off at open that probably produced much "panic" selling, so the day's low was within the first hour of trading. Then the market pulled up noticeably -- even though it was still down from the previous day. It went positive at several points, so the high was above the open, and by 3:30, the market was up by around 330. There was selling toward the close, so there was undefended high territory and the day's close was down 128 points.
Most people will focus on the fact that the market was down again, this time by 128 points. YOU should focus on the facts that: (1) the close and open were fairly close; and (2) a large lower tail emerged on Friday. Lower tails suggest the possibility of a bottom, or weakening of downward momentum. Consistent with this, the RSI(9) is also in very oversold territory.
So, my interpretation is that we are possibly very close to a temporary bottom, as support at 8,000 held, the RSI indicates oversold conditions, and a large lower tail emerged on the most recent daily bar. A few negative notes from the credit market: the 1-month t-bill rate remains below 0.10%; and while the overnight LIBOR rate fell sharply on Friday, the one and three-month rates remain elevated. NEVER OVERLOOK THE CREDIT MARKET!
How can we further decide whether this bottom will hold? How about economic theory? What a coincidence, that's what ECN 327 is all about! What determines stock prices? Interest rates (asset substitution, etc. that we covered in class) and most importantly expected future profits. So, looking forward, you need a forecast of the overall economic picture -- both national and international. But, for extra credit (due at the beginning of class on Tuesday), bring in two graphs, one with daily data, with annotations, showing support and resistance, the other repeating this for weekly data going back as far as possible.
This week should be a very important one for the future of this stock market downturn. Will the G-7 meetings produce tangible results? If not, will the market sell-off further? Will credit markets start to loosen and begin more normal lending again? Follow the bars each day and interpret them for what they convey. Practice like this will help you further understand charting and the information it provides.
