As the Dow Jones Industrial Average (DJI) approaches the psychologically important 11,000 level, you might be asking yourself, “What about Dow 14,000? Can this market hit the 2007 highs?”
The answer is simple: Anything is possible. The 2007 high wasn’t rational in 2007, so why would it have to be rational in 2010, or 2011?
Let’s face it, the market is primarily driven by sentiment. When greed overtakes fear, almost nobody cares about the bearish story, they just keep buying. I will spare you the list of historic examples of markets that should never have been as high or as low as they were, as I’m sure you have a few in mind already.
Advisers are still nervous, and that’s a good thing for the bull market, because a strong bull market needs bearish sentiment. It’s the stuff that fuels the rally. It’s when everyone is bullish that we will likely be at or near a top.
There is still a huge amount of investing capital on the sidelines (in liquid assets, cash or cash equivalents) so when people ask if we are overbought, while the answer is certainly yes, we have to remember that markets can stay overbought for a long time.
Many a bear have gone broke trying to call a bull market top. And many investors have gone broke thinking the market should act rationally when, in reality, it almost never does.
You have to trade the market based on what the most likely next move will be, not what you think it SHOULD be.
Is it too high? Overbought? These are questions the stock traders are asking (not the option traders since the option traders have a built in stop-loss that doesn’t even require exiting the position).
So let’s bring some rationale to this discussion by talking about what some refer to as the “squiggly line theory.”
Technical Analysis: Historical Precedent or Tea Leaves?
The “squiggly line theory” is what some people call technical analysis when they are dismissing it as useless.
Most of the people throughout my life who have dismissed technical analysis have been the same exact people who tell me how much they respect their principles, which are based on their understanding of history.
They recite quotes such as: “If you don’t know history, you’re doomed to repeat it” or, “If you don’t know history, it’s as if you were born yesterday.”
Then, they will tell you (as if everyone on earth doesn’t know it already) that “human nature will not change.”
The point is these principles contradict the notion that technical analysis is comparable to reading tea leaves. Technical analysis is nothing more than an illustrated record of historic prices. It’s history. And as Mark Twain said: “History doesn’t repeat itself, but it rhymes.”
The Answer to the Age-old Question: Fundamental vs. Technical Analysis?
Just as many readers, based on their keen understanding of history, have a very good idea of where the United States is likely headed, socially and economically, a chartist can use the data presented to get a great picture of the likelihood of a stock’s or market’s next move.
Just as the history buff can only tell you what will likely happen next or soon, the technical analyst faces the same limitations.
What Technical Analysis Says About This Market
As of now, most technical indicators call for more upside before a correction.
But when the tide changes, I will write about it, most likely before the majority of investors see it happening, and I’ll tell you exactly what I’m seeing and explain what it all means.
Until then, it makes sense to get bullish on any weakness. But do so with caution. Keep your stop-losses tight, use options to hedge your investments, and don’t be emotional.
Related Articles:
- 10 Tips to Getting Started With Technical Analysis
- 5 Ways to Tell a Stock is Headed Up
- 7 Ways to Tell a Stock is Headed Down
- Technical Analysis IQ Test
The Options Trader’s Guide to Technical Analysis
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