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Market Cycles; Rinse and Spin
Linda Goin
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 Archives |
If you've become serious about investing and you've ventured around the Web in search of tools, you may have come across something like the following description of a chart:
There's a whole bunch of resistance putting the blow of a hammer on the candles. But the stochastic has yet to roll over, even though the trendline is violated to the downside.
EEK! What the heck does that mean? When Cora and I found this tidbit, we were highly amused and confused. We bookmarked the site just to see if we'd understand this "code" a few months down the road. Recently, we decided the above information was telling us the chart in mention was acting a lot like a washing machine.
If your washing machine is anywhere near normal, you have several cycles that will clean your clothes. The basics consist of wash and spin, then rinse and spin. These cycles are somewhat predictable. You can place your clothes in "regular," "gentle," or in low, medium, or high load, or adjust the temperature, and the machine should react to your instructions. If you relate your laundry routine to a stock market chart, you're creating probability based on volume, speed, interest, and cycles.
This is the stock market, according to technical analysis.
First, support and resistance: support is when a stock refuses to fall below a certain level, and resistance is when it refuses to go above a certain level. When a chart is on an uptrend or downtrend, there are walls of support and resistance that keep the chart in balance. When your washing machine speeds up toward the end of a spin cycle, it's hitting a wall of resistance. Finally, the resistance or support will break through to enter the next cycle. This is what happens on a chart, also - whether up or down.
When a stock goes through these walls, it's called a "breakout." You will see a stock begin to develop higher highs and higher lows, or lower highs and lower lows.
When there's "a whole bunch of resistance putting the blow of a hammer on the candles," this means the equity is about to take a downturn. Candlestick charting is a form of following a stock by price, and we'll tackle those a bit later...for now, just know they can indicate trends in a chart, based on opening and closing prices. The candles were indicating a breakthrough to the upside, but the resistance from investors was too heavy to make the move.
The "stochastic" is a probability. Yes, a probability is similar to gambling, or fortune telling, or even making an educated guess whether your washing machine will break down after three years running on seven loads a week. We base our lives and wash loads on probability.
For example, if you place just a few items of clothing in a washer on delicate at low level, you know - from past experience - that your clothing will be treated gently, and the water level will be low and cool. Of course, if something goes awry anything could happen. You could experience an overheated mohair sweater plastered to the ceiling (Mohair in the washer? What were you thinking?).
A "trendline" consists of connecting peaks and valleys. Your children can do trendlines. All you do is draw a line connecting the tops and bottoms of the highs and lows on a chart over a period of time. In other words, you draw a line from peak to peak, and from bottom of the valley to the next bottom, etc. You can begin to see if your chart is on an uptrend or downtrend very easily with this method of marking a chart. You can even begin to see the walls of support and resistance, which run horizontal to the vertical ups and downs.
I'm sure you all have experienced an unbalanced load in a washer. You might even stop the washer to rebalance the clothes if your attention is drawn to the squeaking, bouncing ruckus. When a stock breaks through a trendline, you might see similar movement. Investors might squeak and bounce, and they could trade like crazy. You'll probably see another level of support and resistance either on the upside or the downside. Sometimes the movement is so volatile the market will halt trading until the stock settles in volume and sales. Usually, the stock will settle on its own, especially if it's a small uptrend or downtrend, or if the movement is expected.
Usually, you don't remove your clothes from a washer unless the cycles are finished, or the washer totally breaks down and you need your blouse cleaned by this evening. You can usually conduct your other errands while your washer does its thing...same goes for your stock. There's good probability your stock will continue to grow due to your diligent research and choices in solid companies with excellent value and growth potential.
Of course, there's always a chance a belt will break in the washer, but even then you know you don't need to replace the whole washer. You wouldn't want to replace your uptrending stock over a minor violation of a trendline, either.
What you've just experienced is a taste of technical analysis. You can use these tools to see how your stock reacts - sometimes a stock will weigh heavy with investors who are into technical analysis, and the stock movement will betray the investors' motives. A simple trendline on your company's chart could possibly give you hints to avoid a financial disaster, or clues to invest more before the stock moves up.
Just remember technical analysis relies on the assumption that chart prices, volume, and interest can help predict the future short-term market trend. Unlike the basic fundamental analysis you learned when you examined your company's financials and operations, the value and long-term future of the stock isn't considered.
Of course, when you teach your children the benefits of trendlines and laundry, you can't go wrong.
Until next week,
Linda Goin
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