Explanation Of Why The Dow Jones Industrial Shot Higher By 700 Points In 2 Trading Sessions

It has been a long time since I published something on this site. Perhaps it was out of boredom of perhaps I'm too busy with the stock market. Anyway a few days ago I did an analysis of the Dow Jones Industrial and said that it was a great time to make some money. After falling from 17991 to around 17200, in a week plus, it was ripe for a bounce up in the Dow and this could be a ripe opportunity to make some money for the pros of Wall Street. You can see the simple analysis I posted on Facebook here.

The chart below shows how powerful the move was. I know that there are lots of pro traders out there making thousands, hundreds of thousands and even millions from this anticipated move. Well, I congratulate my fellow traders in Wall Street.

dow had the biggest jump in 2 days since 2011

Normally, I do not do these kind of analysis and show them to the public. People (except traders) will not read them as it is not much of a concern to them at all. But I have found that sharing and writing sharpens my skills since I have to explain it to others in a simple way. It helps clear things up for me.

How did I come to the conclusion that a rise is around the corner for the Dow?

I use an analysis called technical analysis which uses charts and patterns to anticipate what will happen in the future. Some have criticized technical analysis saying it does not work. I think there is some truth in it since how you interpret data depends on your experience and knowledge. As with all other professions in life whether it is medicine, law or dentistry, analysis and tools aid the diagnosis of the problem. But it is the experience of the participant that achieves the final result.

The first thing I saw was that the Dow Jones Industrial was at a support.

After making a new high in November, the old highs in September which acted as a resistance now becomes support. It is an old maxim of technical analysis that old highs once breached will act as the new support. It's much like an army that conquered a new territory. When it is attacked later and retreats, they try their very best to defend the newly gained boundaries.

Furthermore, the Dow was also nearing its 50 MA support. Traditionally, the 50 MA is a very strong psychological support in stocks as most traders or fund managers will look at the 50 MA as a support. I believe its overused and also misused but sometimes I find it helpful to know what the majority of market participants are thinking.

The next thing I saw was how the S&P 500 Index was doing.

The SPX acts pretty much the same like the Dow. It made new highs and the old highs now act as the new support. The highs in September is a rounded top which acts as a better support than highs that are the V type. Also, you can see that the SPX is at 50 MA support as well.

One thing to note when doing analysis of the stock market, you need to look at different indexes to get the overall feel of what happens. That is why I always look at the Dow, S&P 500 and also the Nasdaq composite which are tech heavy.

Below is a chart of the Nasdaq Composite.

Again it pretty much tells the same story as the Dow and the SPX. There is price support and also the 50 MA Support.

Well, the 3 indexes are firing on all cylinders!

When you have 3 major indexes showing strong support underneath, you can be pretty sure that the line of least resistance will be to go up. Just like water flows to wherever there is less resistance, stocks tend to take the easy path. How far it will go or when it goes we do not know but it does give us a bias to the upside.

To double confirm, I also look at the volatility index which is a measure of fear in the markets. Remember what Warren Buffett said, "be fearful when others are greedy and greedy when others are fearful"? Basically, this volatility index shows us when an extreme in optimism or fear abounds so we can go against the crowd which is so often wrong.

The chart above shows the CBOE Nasdaq Volatility Index, it moves in the opposite direction of the indexes. So when the indexes are up, the VXN is down. When the indexes are down, the VXN is up. You can see that the support and resistance areas pretty much coincide with short term tops and bottom of the major indexes.

One last thing I want to show you is VOLUME and a technical indicator called stochastics.

Usually, volume precedes price. That is because volume in a stock or index is made up of trading activities by market participants. When you see extreme volume that is way more than the usual normal volume, you know that something is about to happen.

Charts on this page are courtesy of freestockcharts.com

The chart above shows the SPY which is an ETF of the S&P 500 Index. Basically, the SPY mimics the movement of the S&P 500 Index. The SPY is one of the heaviest traded instruments on the planet and so it kinds of represents the herd mentality of market participants. And as you know the majority are usually wrong.

In the chart above, you can see that in October, the correction ended with a climactic volume. Climactic volume is volume that is much more heavier than usual volume. What this tells us is that people are so scared that eventually all those who want to sell have already sold. When you see everybody dumping their stocks in panic, that is usually when the market will turn around.

If you look at the chart of SPY in December, you will also notice that volume is reaching the heights it reached in October when the market reversed the fall. So, it tells us that the probability of a reversal occurring is getting better and better.

Finally, I used a technical indicator to help confirm my analysis. Many amateurs and newbies put a great emphasis on technical indicators. I find that they can be misleading at times but I tend to use it as a confirmation of my analysis. Since so many people are using technical indicators, I also use it to tell me what the majority of traders are thinking.

Many traders will pull the trigger when their indicators tell them to trade. So when I saw that the Stochastics is oversold (below 20) I know that there will be lots of traders who will jump into the index soon. Their buying will help to lift the market.

Conclusion - How High Will The Stock Market Go?

So there you have it. That is how a trader does his analysis. If you have learned a thing or two from this article, do press the facebook like button below.

The next question all of us might want to know is how high will the stock market go from here? Well I do not know. This looks like a a very fast move up and from experience, the Dow could just fall as easily in the next few days. Or it could move higher. I really do not know at the moment except to monitor the indexes day by day and perhaps hour by hour. That is what most professional traders do. For many pros, they would have got in at the low and as the market rises, they will be selling bit by bit to book their profits. They don't usually sell at the top but I guess that's how you make money in the stock market.

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References:

Forbes (The ultimate site for billionaire rankings)

CelebrityNetWorth (The ultimate site for net worth of celebrities)

TheRichest (Great site for things about money and rich people)

Wikipedia (Greatest site on earth for lots of information)