Stock Market Indexes Now Breaking Through Support

Stock Market Indexes

U.S. stocks have held up pretty well throughout the upward move that we’ve seen since last Christmas. The month of May has not brought good tidings though and we may be headed lower.

There is an old saying in the stock market which tells us to sell in May and go away, meaning stay out of the market for the rest of the year. Few stock investors would ever seriously contemplate being out of the market for most of the year though, and most aren’t ever out of it at all, even when things look like they are going to crash, and even when they do crash.

There are some years where it would pay to just stay away period, years that the market puts in a loss. General rules based upon the calendar, especially those that involve our going away for 7 months of the year, don’t really work that well though. Stocks have an upward bias overall and being out of the market generally for that amount of time will just reduce your returns, because stocks go up generally from June to December just like they do all year round.

If we are looking to use this rule in 2019, since the rule has us going away at the end of May, not at the first of the month, followers would be just getting ready to go away right now, and would not have missed any of the disappointing results overall that stocks have provided us this month.

Sell in April, at the end of April that is, and go away, therefore looks more promising, but this really isn’t a strategy that pans out very well either, even though it would have spared us at least the month of May in this particular year. For any trading rule to make sense though, it has to work over time, and we can’t just take an instance or two and create rules that are supposed to be valid generally, because this is a very insignificant sample.

Months don’t really matter much here though, but what does matter is the distance between where we once were and where we are now. It just happened to be that the market peaks for 2019 so far happened around the first of May, where the markets have given back 6% of its 2019 gains this month.

A lot of the movement in stocks is based upon momentum, where a move in one direction or another makes it more likely that it will continue, as investors see price move up or down and join the crowd in the direction it is headed.

Stocks Always Involve a Battle Between the Bulls and the Bears

There are always forces on both sides battling it out though, and what we need to be aware of when we are looking to decide whether a trend is reversing or not, or rather, the probability that it will, is the extent of the fight on each side. The bears have clearly been winning the battle in May, although the bulls may not be ready to give up their trend in 2019 quite yet, and we’re still up a nice amount this year in spite of this rocky month.

We look at various things to determine this, whether this be earnings, where future interest rates may look like they are headed, the bond market, the view of economists, the progression of events such as the trade war that is going on now between the U.S. and China, trends in economic growth including concerns about recessions, and so on.

One of the things that we look at, or at least should be looking at, is charts, and while charts only contain past data, this data does move in trends. These trends, as they play out, can tell us a lot.

It is said that everything we know about the present and the future, as well as any beliefs or opinions about it that are being acted upon, is contained within the price of stocks. This is seen as one of the major tenets of technical analysis. This isn’t quite true though, as this model assumes complete efficiency, and stocks are far from that.

Rather than expressing the sum total of all influencing factors in an instant, something you could see on the tape for instance, what we do have instead is information that is both digested and acted upon both immediately and over time. Almost all of it happens over time.

A good example of this would be the concerns that some people have over the possibility of a recession coming soon. These concerns are not black and white, but instead are of various magnitudes that change over time, where we have a certain threshold that if reached will spring us into action to sell or buy shares.

The concern itself can’t really be quantified very well, as even if we take polls, this can tell us that investors in general are concerned to some measurable level about this, but this information isn’t actually useful unless it is put into perspective with their breaking points, which we really don’t know, and they may not know with any degree of certainty either.

These influencers are therefore not static but dynamic, and not only do they change over time, the direction and magnitude of the change itself can influence the rate of change.

We can measure these things in a way that does matter though if we just look at the change and the rate of change of price. Since we’ve come down quite a bit this month, we can see that concerns like this are building, as are ones about the trade war, the slowing economy, the dollar, the bond market, or anything else that may be shaping our investing and trading behavior.

Technical analysts interpret these moves, and while it’s not that difficult to build one’s skills up to be able to use this information to your advantage, there is some skill involved to be sure.

We’ve Just Broken Through a Significant Support Level

One of the first things people learn when studying technical analysis is how support and resistance on a chart may influence things. It is true that as we approach a resistance level, people may be more likely to sell in fear of the potential resistance, or more people may buy when we reach support levels, so some of this is self-fulfilling.

Indexes don’t work this way quite like individual stocks do, because while indexes in themselves are traded, there’s also the trading of the individual stocks to be considered, and they all have their own support and resistance levels as well as everything else that we may take into account when looking at charts, and this often will differ from the main index.

There’s more to this than just the self-fulfilling part though, and we always want to look beyond just these support and resistance levels and consider the way things are moving between these two points on the chart. If May had been pretty flat and then moved a little below support late in the month, this tells a different story than if we have lost 6% on the way, because the latter has more momentum behind it.

We just broke a pretty meaningful support level this week, and that might have us thinking that this alone is a reason to be more bearish, but there’s more to this story than just this level. Of course, it’s not a good sign that we broke this level this week, and when you throw in all the concerns out there about the economy and trade, this does look like one more reason to sell. It’s one more reason to be cautious though, at the very least.

However, what is more meaningful from a technical perspective is the negative momentum we’ve had this month, and our response to it. Halfway through the month, we had a little rally going where it looked like the bulls were ready to regain the upper hand, as has happened earlier in the year, but this time the bears pushed back and have now driven us lower than ever.

Sure, Donald Trump did slap the markets which put an end to the rebound, but it’s more that the market has not really fought back since that is troubling here.

When we throw in the fact that a lot of the gains this year have been from upward momentum caused by companies buying their own stock, not only the effect of the stock purchases themselves but the others who have seen the train moving in that direction and have jumped on it, this is another reason for concern, since the pace this has set cannot last for all that long.

We’re now sitting with an overall negative view of the market this year by investors, who have been pulling out more money from the stock market than they have been putting in, along with escalating fears about the economy and the trade situation, and now, the charts breaking down in a meaningful way. The sum of all of these forces are not to be ignored and at least has the potential to put us into another bear market.

We’d have to see a few more months like May for this to happen, because an official bear market only gets named when we lose 20%, and two more like this in succession would still leave us a little short. We did lose the 20% during last year’s bear market, but we made it back pretty easily, so the 20% isn’t necessarily the kiss of death for a larger bull trend.

Breaking through this support in itself isn’t all that big of a deal though, but since the expectation when we approach support is that this should stimulate buying, when we don’t see it, that part might be.

Right now, we would have to say that stocks now have a negative bias, and this means that if we had to bet on how June would end up, it would seem more likely that we’d be lower rather than higher compared to where we are ending May.

Timing stocks most often results in a wait and see approach, and while May has been a bad month for the bulls, and they might be down right now, there is still the potential for a comeback. Good news would likely spur some of this on, but if things remain at the status quo, given that the buyers have been more reluctant to buy this particular dip, we may end up seeing this continue next month as well.

Once we reach the real tipping point in a downward trend, this reactionary buying really dries up, and while we’re not quite there yet, there are some real signs and this all bears watching closely.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.