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Last week (1,2) I talked about how the DJI should be breaking through the 12,700 barrier. We did not break through it, and I starting to become concerned. Some technical analysts will draw pretty pictures with lines in multiple directions, but we are hitting a resistance point. I like technical analysis, but use it in conjunction with mathematics and probability.

Here is what I would do, take some money off the table, not all. How much you want to take off the table depends on how nervous you might be. Last week I was so-so about locking into profits this week I am motivated to lock into profits. Then sit back and wait.

I see the market playing out in one of the following two scenarios:

The bulls have the upper hand and you should only put money back on the table when DJI breaks through 12,800 and not a point earlier. I am thinking if 12,700 is broken it might be a fake out before the bears take control. Right now the market is not convinced it wants to reach 12,800.
The bears have the upper hand, and you know the rule never catch a falling knife. I am thinking if the market falls wait until we reach 11,750 and then slowly think about putting money back on the table. My “beyond this is a major problem” support level for a bear run is about 11,250 to 11,500. I am doubtful it will break beyond this level, but you never know.

Let’s see what next week gives us…

Hello There Mr Roboto!
(the song and era says it all... http://www.devspace.com)

Friday, Feb. 2, 2007 by Christian

Add to del.icio.us | Digg this story | Filed under: Stocks, Fundamental Analysis

6 Comments Add your own Subscribe

1. Jason | February 2nd, 2007 at 7:01 pm

I’ve just been reading up on how the DJIA is a “poorly constructed” index to follow. From Ken Fisher’s “The Only Three Questions…”, here are the top reasons people shouldn’t use the DJIA as an indicator of the overall market.

(1) It’s only 30 stocks and represents less than 1/4 of the market value of all US stocks.
(2) The stocks are picked “arbitrarily” by the Dow committee.
(3) -the biggy- The index is a “price-weighted index”.

Why are price-weighted indexes so bad? Because stock splits and reverse splits, while not having an impact on the stocks market share or economic impact, will have an impact on how that stock effects the index. Here is the Forbes article by Fisher that explains this:

http://www.forbes.com/columnists/free_forbes/1999/1115/6412310a.html

Now I don’t know if there has been recent splitting activity that could be affecting the Dow, but it is assumed that the index is messed up already from all the previous splits and shenanigans.

Also, the S&P (which is weighted by market cap) also looks a little overbought anyhow. I think a pull back could come. I don’t think we’re going into a bear market though so it might be best to wait it out if you’re not sure of your ability to time it.
2. Christian Gross | February 3rd, 2007 at 12:18 pm

I agree, but at the same time want to point out that an index is an arbitrary measure anyways. You can slice and dice the numbers however you please, but there is no single correct way to calculate the market. If there was a single correct way then we wouldn’t have oodles of indicators and indicies. I would even go so far as to say that technical analysis and any attempt to rationalize the market into one neat formula is an arbitrary measurement.

For example, take volatility. When you want to price an option you plug in the interest rate, time to expiry and a couple of other factors. Then the biggy is volatility. You plug the numbers into an option pricing formula, and volia you get the “correct” option price. Yet, the number you get probably is not going to be the market value. At that point you make a judgement of whether or not the option is priced correctly.

I agree that the DJI might be flawed, but I like the DJI due its long history. When I look at an index I look at snap shots of less than a year. And then I compare multiple snapshots just to give me some sort of idea of what has happened in the past. I don’t use the past as an iron clad rule with numbers, but rule of thumb.
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