Monday, June 7, 2010

Ceilings and Floors

This week will be a momentous week.

Thursday, the Dow Jones Industrial Average closed below 10,000, and it didn't close above that mark on Friday. Worse, it didn't break 10,000 even during intraday trading on Friday, and that's a bad sign.

I never really understood the true psychology behind ceilings and floors on the stock market. What I mean is that I understand the statement that investors cling to numbers that fall on nice, definable boundaries. Furthermore, I understand that once those boundaries are crossed, it's not easy to cross them again in the near future and in the opposite direction. Still, I don't know why this happens.

But that doesn't matter. What does matter is that the DJIA is in dangerous territory this week. Last week's jobs report (CNN Money had a nice write-up) had a very important detail buried in it: in spite of the fact that 431,000 jobs were added in May, 411,000 of those jobs were for US Census based work, which is very short term work indeed. Doing the math, we see that the private sector only added 41,000 jobs, which is a very small number.

(Edit: minor correction proving that my college degree doesn't mean I can "do the math." The government added 411,000 jobs but cut 21,000 jobs, which is how you arrive at a total of 431,000 jobs for the month. -Larry)

Add to this the economic worry in Europe and the oil sector worry due to the BP fiasco in the Gulf of Mexico and we see a nasty picture starting to form and that's without taking the housing market into consideration. Regarding that, the April new housing starts report indicated an increase in this important sector, but applications for new building permits declined. This means that any optimism will be short-lived. And when coupled by the already high inventories; job market woes (dissuading people from investing in real estate if their jobs are on shaky ground); and tighter lending requirements you can see that the housing market is still in for a rough ride.

Still, everything for the moment rides on this week.

If the DJIA can break through the 10,000 ceiling in a convincing fashion then we will have dodged the economic equivalent of cardiac arrest yet again. "Convincing" means, to me, that there must be good trading volume and (!) when 10,000 becomes a floor afterward, a test of that level should pass (i.e. we don't cross into the sub-10,000 territory just as easily). Otherwise, we may be in for a rough 6 months again as we start to define what may be the second dip in the W pattern that I have been warning about for months now.

Ironically, if you had been watching the DJIA graph you would have known to sell short against the index back on May 3. I typically use a two-line exponential moving average (EMA); MACD; and Relative Strength Index (RSI) as my trend analysis tools (above and beyond open, close and volume). The MACD already showed a negative outlook but on May 3 the RSI also showed a sell signal. Had you sold short before the end of the day you would have made 10% in one month - not a bad haul in my opinion. (Still, hindsight is 20-20 so who knows what I would have thought on May 4 had I looked at the graphs then...) With the EMA also showing sell on May 28, it makes a compelling case to at least consider selling short again.

Disclaimer: I am not a stock analyst; Certified Financial Planner; etc. My statements above are my opinion only and do not represent a solicitation to buy equities; sell equities; do the dishes; or take a vacation. Use at your own risk.

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