Measuring human behavior is not the same as measuring balance sheet items. People as a group will move from euphoric optimism to dire pessimism at the extremes. Group behavior is the underlying premise of technical analysis. As an aside, the mass hysteria surrounding Covid 19 and which has played a large role in market action, is on full display and is in line with manias and hysterias of the past. People may wish to read the classic book by Charles Mackay, Extraordinary Popular Delusions And The Madness Of Crowds. This will give perspective on what we see in much of the world today.
While you can never predict with precision the actions of one data point (person), the actions of a population can be estimated with some confidence using statistical analysis. One of those tools of analysis is the fibonacci sequence of numbers found to exist in many aspects of nature. This projection tool has been determined to be useful in market projections because of its implicit gauge of human behavior. There are volumes of academic books detailing the use of these statistics, but it’s not our intent here to prove validity. It is but one tool used to ascertain market activity and not to be used in isolation.
Suffice to say, fibonacci projections are used to estimate where prices may move both on a trend basis as well as on any retracement. In the case of recent events, it’s useful to use such projections to determine where prices will settle before or if any inflection occurs. The charts below show the fibonacci lines super imposed upon the 3 major markets, the Nasdaq, the S&P and the Dow indices.
While the charts may be confusing, the salient point is that all 3 markets have reached the projected target levels based on the expected fibo statistic. That area is represented by the 161.8% line on all three charts. In fact, the Dow and S&P charts have nominally breached these levels, but prices have rebounded somewhat above them. To be clear, these are not absolutes, but given the panic that has happened and the accompanying volumes, these are levels that are likely exhaustion points in preparation for a possible turn.
So now that we have established target levels, the next thing needed is a turn in momentum statistics. Thus far, there has not been enough activity to turn such statistics around. If markets are able to hold here, this will mathematically turn some momentum indicators and give clues that a low of some kind has been made. Much damage has been done to the powerful uptrend that’s been in place for over a decade, but the speed of the selloff has a silver lining. It means that markets suffered a shock that’s not necessarily evidence of underlying structural weakness that a longer protracted decline would indicate. While it may take a while for the markets to recover, I expect that the multi sigma declines of many stocks will recover very quickly when momentum turns.
It’s key to remember that we are assessing crowd behavior and not measuring balance sheet values and as such, we rely on charts to provide the clues. As mentioned in previous pieces, look for the reversal doji bars. These will be found at the inflection points when the crowd mood has changed. We look for evidence in the advancing issues versus declining issues and we gauge the volatility change in options pricing and sentiment gauges. Markets discount news and when a rally starts, it will be in the midst of bad news becoming old news.