Sunday, March 18, 2007

Is It Safe To Buy Stocks Again?

Many market analysts study corporate profits, interest rates, the general economy -- these are called fundamental factors. Other analysts study stock price charts, their patterns, and various indicators calculated from market action -- these are called technical factors. For various reasons, technical factors can often tell you more about market conditions than fundamental factors, especially in the short term.

One good way to help you figure out what's going on in the market is a commonly used technical market indicator called the MACD (that stands for Moving Average Convergence-Divergence). It's not perfect (no indicator is), but if you plot it on a weekly chart, the overall state of the market becomes much more apparent.

You can do this on many free charting web sites; my favorite is JavaCharts from Here are the steps to follow:

1. On the JavaCharts web page, first enter the symbol to chart. For instance, on this site the S&P 500 index is $SPX.

2. The next pulldown list determines the kind of chart. The simplest option is to leave it as a line chart, which shows the closing price every period. You can experiment with the other styles to see the difference; for example, bar charts and candle charts show the opening price, high, low, and close for each period.

3. In the next pulldown list, choose the desired time duration for the entire chart; for instance, one year.

4. In the next pulldown list, choose the period for each data point. For this example we are using "W" which produces a Weekly chart; i.e., there is one point on the chart per week.

5. Right-click inside the chart and choose Studies -- Apply Studies. Click the pulldown list entitled "Select Studies" and choose "MACD (2 lines)". Then click Close.

6. You now see an area below the main chart, whose main feature is two lines. On mine, there's a solid blue line and a dotted red line. Now look at where the lines cross -- those are the signals. There are variations in how to use this indicator, but the simplest way is, when the main line crosses below the dotted line, sell. When the main line crosses above the dotted line, buy.

Notice this signal gave a sell signal in May 2006, soon after the market started on its steep drop into the summer. Then it gave a buy signal in early August, soon after the market launched a powerful rally that ultimately gained nearly 18% in 7 1/2 months.

Please note that even though this indicator is pretty good, these are not standalone buy/sell signals and should be considered in combination with other indicators and market conditions. Still, you could do a lot worse than making the MACD a major guideline. The longer chart periods, especially weekly and monthly, are more reliable than shorter ones like daily and intraday.

Note that the nature of the signal is reactive rather than predictive, so it would not have gotten you out before the recent drop. But it can help you recognize when the trend has changed and thereby help prevent further losses.

So what's it saying now? It went to a sell signal in late February (due to the recent plunge) and is still on its sell. So even though the market could rebound right away, the odds are against it. Bottom line, it's not yet safe to get back in the market.

This also agrees with other information I'm seeing that it's not yet time to buy. In fact, if you haven't sold already, you still have the opportunity to do so. Even though I don't think this will be a severe correction, you never know how far down it might go.

So now you have a tool which should make you a lot more comfortable about being in or out of the market. In general, signals using the weekly chart occur every few months. If you don't want to trade even that often, use a monthly chart (expanding the view to about 5 years or more, so you can see past signals better) instead of a weekly one. On the monthly chart, the MACD gave a buy signal for the S&P 500 back in May of 2003 and that buy is still in effect.

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