Is the S&P ready to drop?

The Wall Street Journal had an interesting column on Monday.  The article warned that the technicals of the market imply that a downturn is quite likely.

Investors are desperate for any map to help navigate today's treacherous stock markets. One that might leave them seasick is relying on technical analysis from charts. First, there is the question of whether stocks are filling out a "head-and-shoulders" pattern, or an "island reversal." If the S&P 500 falls below its June lows, it would complete the head-and-shoulders (a high, a low, a higher high, a low, a lower high). Meanwhile, there are ominous signs of an island reversal. In that case, indexes fall rapidly between sessions, forming a "gap" in the days' trading ranges, and then quickly "gap" back higher. Should they occur, the two patterns are thought to signal a downturn ahead.

Before these patterns could be completed, the S&P would have to fall under its 200-day moving average, 1277, itself another key chart figure. To complete the head and shoulders, the number is 1265—only 3.1% below Monday's closing level of 1305.

It is important to understand technical analysis but I honestly do not believe that you can completely rule your investment life by looking at charts. There has to be some understanding of the business of the company that you are choosing for an investment. You need to understand how the company makes money and its historical ability to grow. However, there is momentum in the market and sectors tend to move together so technical analysis does give us insight into the market direction.

It is also important to remember that some companies will still be winners during a market downturn.  Just like there are loser companies during boom times. So while the market may be doing badly, your particular choice for an investment may be doing quite well.

Should you react to this thought process?  Maybe.  You should at least be a bit defensive in your positions.  If you have made a significant gain in a stock, it may be time to take some of that profit off the table. Also, major market moves invariably hit larger cap stocks more heavily, so you may want to be a bit more defensive in your position in large caps. This would surely apply to the DOW 30.

Just as all boats rise and fall with the tide, stocks are influenced by the other companies in their sector and in the market in general. When news of government defaults are constantly in the news, it is simply wise to be extremely cautious with your hard-earned money.

In the next 4-6 weeks, I strongly advise you to watch the technical indicators. I personally watch the 10- and 20-day EMA for my investments. If you think that is too quick, you should at least be watching the 35- or 50-day averages.

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