200 Day Moving Average, Death Star IPO, Golden Cross, Resistance, Support, Cup and Handle, Head and Shoulders (and we are not talking shampoo) and a lot of other market technical phrases that have been thrown at investors at an alarming rate over the last few years.
What does all of this mean? Is it black magic or market Voodoo? How do these market observations and other technical trading terms affect my investments? These are a few of the many questions investors have been asking as these and other terms are becoming common place on CNBC and the Wall Street Journal.
I am not going to attempt to explain the “magical” powers of market technicals, but instead I want to discuss the bigger picture of technical trends and if they have a place in longer term investing.
As defined by Investopedia, Technical Analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Technical analysis is thought to be the oldest device designed to beat the market. Its origins date back to 1900 where Charles H. Dow of the WSJ developed the “Dow Theory.” The Dow Theory predicts market movements based on the relationship between the Dow Industrials and Dow Transports.
Technical analysis can, at times, provide a method of predicting market trends over a period of time, but basing investment decisions solely on market direction and predictions is not a sure-fire method of growth. Technical analysis is far from perfect because at the end of the day company fundamentals drive growth, not 50 and 200 day moving averages.
Technical analysis does provide us another prism in which to view current market sentiment and if we should be looking to add to the fundamentally strong companies or wait for possibly better entry points. Momentum and sentiment are near term keys finding stocks that are more likely to move up or down in the near term. The goal is not to pick the bottom or top, albeit a nice thought though, but to use market direction to search for better entry and exit points to help enhance returns.
200 Day Moving Average: An indicator used by traders to determine a stock’s closing average over a period of 200 consecutive days. Most traders use this technical indicator to determine trends in the market. In theory, those stocks that continue to close above the 200-day line would be considered healthy, but often those stocks are considered volatile because they usually reverse course and head downward.
Death Star IPO: An initial offer of stock to the public by a company that has garnered a lot of attention from investors who have high expectations for a price “explosion” once the stock is released. So named for the impact they can have on the entire stock market just as the Death Star weapon from the Star Wars movies had on planets in its path. Such IPOs have been rare since the rash of dot.com companies that went public in the 1990s. A recent example of an explosive public offering is Google in 2004.
Golden Cross: An event in forex trading (The exchange of currencies between two or more countries on a recognized market) where two moving averages are moving in the same direction implying that a currency will move in that direction within a short period of time.
Resistance: Inability of a stock to rise above a certain price (resistance level).
Support: In technical analysis, a price level which a security has had difficulty falling below.
Cup and Handle: A pattern on a bar chart that is in the shape of the letter “U” over a period of between 7 and 65 weeks. Once the stock price reaches the second peak of the “U”, some technical analysts believe that the price will fall as investors who bought at the previous peak start to sell their shares.
Head and Shoulders: A technical analysis term referring to a chart formation in which a price exhibits three successive rallies, the second one being the highest. The name derives from the fact that on a chart the first and third rallies look like shoulders and the second looks like a head. Believed by technical analysts to be a bearish indicator.
Written By: Jeff Mussatt, CFP®
[1] Definitions from http://www.investorwords.com/ (an excellent resource)