The Bottom Line
- Many successful long-term investors focus on the fundamentals of valuation – how much the market appears willing to pay, both individually and in aggregate – for a dollar of today’s or next years’ earnings, growth, dividends, assets, or revenue.
- But there’s also a long-standing cadre of “technical” analysts and traders who largely ignore all that, focusing on just two factors: prices and trading volume.
- The two camps have viewed each other with suspicion for decades. But when markets get volatile, the “technicals” can be surprisingly insightful.
- That’s not to say that technical factors are in any way predictive; rather, they can offer guideposts that are useful in understanding the characteristics of market conditions.
- One basic set of technical indicators is the simple moving average of closing prices. Experience has shown that the 50-day, 100-day and 200-day moving averages appear to show boundaries of price behavior, at least in the short run. The reasons are unclear; explanations vary from the psychological to the “it just works”. Either way, they have become important components of market perception.
- The breakout of volatility in 2018 is an excellent example. February 2 saw the first intra-day fall of greater than 1%; Feb 3 briefly touched its 100-day moving average before recovering slightly. The following three trading days “tested” the moving averages by breaching the 50-day. The following day, Feb 9, which felt to some like a free-fall for a few minutes, traded between the 100-day and 200-day moving averages before bouncing back.
- Thursday, March 1, breached the 100-day moving average on the downside again, partially in reaction to the news flow. That’s one reason the technicians consider the S&P500 to be re-testing its lows. Only time will tell how the S&P 500 will test these averages again over the next days, weeks and months.
- The bottom line: perhaps only because observers believe in them, these technical measures carry explanatory power and can offer comfort. But in the longer term, financial markets pay for tangible economic value, based on present or future value. That’s why fundamentals-based investors often lay the groundwork for future outperformance by choosing among good companies’ stocks when they periodically “go on sale” for technical reasons.