Archive for stock market
Stock Market Analysis – Negative Divergences
Posted by: | CommentsDear Traders
It was a tough day on the US Markets yesterday and as I write this most of the major indices futures are negative. This could be a continuation of the correction that began on the 22nd of February 2011.
Taking a look at the chart of the S&P 500 we see there are a number of technical factors that support the assumption that the market will continue the short term downtrend is has just begun.
Click to Enlarge - SP500 Negative divergences of RSI and MACD - Chart Courtesy of Worden Brother Inc.
- Since December 2011 the market embarked on a strong bull run, yet RSI 14, 2 has formed a long negative divergence.
- In my last post on January 22nd I warned of a negative divergence forming – the market has continued to move up but is now looking significantly weaker.
- Since February 22nd, RSI has seen a strong drop and MACD’s charachter has changed from positive to negative.
- We have seen a volume surge as prices have moved down since February 22nd, which is usually a bearish sign.
What is a Positive or Negative Divergence in the Stock Market Chart?
A Divergence is a way for us to compare the direction of an indicator with the direction of price. When the indicators start to move in the opposite direction to price this is known as a divergence. Positive Divergences refer to when an indicator starts to move up as price is moving down. A Negative Divergence is when an indicator moves down when prices continued to move up.
Ben Bernanke suggested yesterday that a continued rise in fuel prices would negatively impact the US economic recovery. That is not rocket science, is is simple economics. We may see as fuel prices are continuing to rise that this will affect the stock market directly.
Is the Market already overpriced?
The US economy is in a fragile state and the debt burden it bears is absolutely incredible. Trying to support that debt burden in combination with high unemployment and the Obamacare costs will be tough. Having a fiscally weak president is also not helping the matter. The US is a fantastic and dynamic place to do business, but at some point it’s leaders will need to start to manage Fiscal and Monetary Policy responsibly. It can of course inflate its way out of its debt situation. But as we know strong deflation or strong inflation can be catastrophic for the stock market.
Historic PE Ratio of the SP-500 Index Source: http://en.wikipedia.org/wiki/P/E_ratio
The above chart shows the PE Ratio of the S&P 500 historically (blue line), you can see how overpriced the stock market was at each of the major Busts;1929 and 2000 specifically. Today we are at a PE of circa 22, which by any stretch of the imagination is not cheap. One could say given the state of the US economy and the challenges it has ahead, it may be overpriced.
Summary
In summary, we may be looking at a short term trend change to the down side. Will it turn into a medium or long term negative trend? Only time will tell. But if inflation increases significantly or energy prices continue to surge then I suggest it will. Keep this in the back of your mind as you place your trades.
Chapter 2 – Why do Booms and Busts Occur?
Posted by: | CommentsThis is an excerpt from the Liberated Stock Trader Book and Training Course.
Why do Booms and Busts occur?
Take for example the famous DOTCOM boom of 2000. Greed surged into the market place on the misplaced belief that new internet based technology would fundamentally shift the market dynamic and business models of the future. Technology became fashionable and “Bricks and Mortar” businesses were perceived to be outdated and almost worthless. This paradigm shift meant that money poured into technology stocks at an unrepentant rate and money poured out of “Bricks and Mortar” stocks at an equal rate.
A tell tale sign of problems to come was really noticeable when stock analysts would suggest Price Earnings valuations on tech stocks of 200, 300 or more were reasonable even though he companies in question had never made a profit. The Price Earnings Ratio is the ratio of the Stock Price to its actual earnings. If a P/E Ratio is at 30 then it would take the company 30 years to earn back the share price. The higher the P/E ratio the higher the expectation that the stock will perform well in the future. You can also see the P/E ratio as a valuation of the worth of the stock, if the P/E is 200 you are essentially paying 200 times the earnings capacity of the company.
In the Year 2000 the P/E Ratio of the S&P500 reached nearly 45. This was an all time high and essentially indicated that the expectation of the market participants was completely unrealistic. By the time the inevitable correction completed the P/E Ratio for the S&P500 had halved to just over 20. Much of the greed and hype was fueled by professional analysts and so called market gurus. They became greedy and euphoric, a heady mixture. When everyone slowly began to realize that the the huge profit expectations would not be met by the tech industry, the entire sector collapsed bringing with it other other industries, indexes & markets. The Tech Bubble had burst.
How does this affect our investments?
The boom is good for our investments in the short term but only if we move into cash before the bust, which of course only the enlightened few ever manage to achieve.
So who suffers the wrath of the Bust? The private investor, you and I! We lost money in our pensions, our mutual funds, and our stock portfolios; we lost jobs, earning power and our appetite for risk.
It seems that the time interval between economic crisis and the boom bust sequence is happening at shortening time intervals, so it always pays to beware. When every analyst is screaming “Buy Buy Buy” and acting like the best thing in the world is happening, that is the time to be most careful. When all the market reports are reiterating what a depressing time it is, how there is no future in the stock market and when prices have lost 20% or even 50% of their value, that could possibly be one of the best times to buy.
Other Chapters of the book are here
Chapter 1 – Essential Stock Market Knowledge – Fundamentals
Chapter 2 – Why do Booms and Busts Occur?
Chapter 3 – Stock Market Cycles – Business & Economic Cycles – Kondratieff to Kuznets
Chapter 4 – Is the Company in great shape – P/E Ratio
Chapter 5 – How to find the best stocks
Chapter 6 – Japanese Candlesticks – Bullish Reversal Patterns
