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Technical analysis has never been given the same respect as fundamental analysis, mainly because it's only concerned with a stock's price, while the latter looks a whole host of issues including a company's sales, earnings and new products. To that end, there can appear to be an element of voodoo about technical analysis. What is exactly is "meaningful" resistance or an "important" support level -- two concepts practitioners of technical analysis use when trying to determine the direction of a stock?
At its most basic, technical analysis is the study of market trends. Analysts and investors evaluate the price action of securities themselves to determine whether or not to invest. The basic premise is that all the information known about SodaStream (SODA) or General Motors (GM)or Orix (IX) or the Nasdaq 100 (QQQ) has been incorporated into its price, which is the primary indicator investors should monitor.
Just as a sailor doesn't control the wind but navigates his ship so as to exploit it, the technical analyst's job is to find out which way the wind is blowing -- and position his portfolio accordingly.
Of the wide variety of technical indicators, few are more durable than the 200-day moving average, which uses roughly a year's worth of trading data to provide a big-picture indicator of a stock or market's longer term trend.
Calculating a 200-day moving-average is basic arithmetic. Simply add up the prices over the preceding 200 days and divide the result by 200. As older values are dropped and newer prices added, the average "moves" along with the price itself. Most online quote engines, including one at Smartmoney.com, will plot the indicator for you on nearly any security.
Simplicity is part of its appeal: When XYX is trading above the 200-day moving average and the 200-day moving average itself is climbing, the trend is considered positive. When XYZ is trading below the indicator, which is also falling, the trend is seen as negative.
A Line in the Sand:
S&P 500 with 200-day simple moving average 1 year
That information is crucial, considering the biggest advantage you can have in the market is trading with the trend. Many strict technicians won't even consider buying stocks below it.
In that vein, many are keeping a close eye on the S&P 500, which in recent weeks has dropped enough to nearly pierce the 200-day-moving-average for the first time since last fall. The S&P closed at 1268.45, just a fraction above the current 200-day moving average reading of 1,263.47.
Digging slightly deeper, the broader market shows a similar indecisiveness, with barely 53% of stocks above their 200-day moving averages, compared to 70% last month, according to Barchart.com.
There's a tendency to overdramatize otherwise pedestrian market numbers, whether it's Dow 10,000 or $100 per barrel of oil. With ego involved, we have a habit of giving arbitrary, imaginary lines in the sand more importance than they actually deserve.
Yet the 200-day moving average, because it is an impartial and longer trending indicator, shouldn't be so lightly dismissed. While markets often seen chaotic, especially given the rapidly changing headlines, they do move in trends which tend to persist over time.
As the S&P 500 dips below the 200-day moving average, now is obviously that time. If stocks can't muster the strength to remain decisively above that line in the coming days, active investors are obliged to take a cautious approach when putting new money to work.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.
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