Tuesday, July 24, 2007

Dow 14000 - The High Water Mark?

Last week, all eyes were on the next all-time record for the oldest and one of the most important barometers of stock market performance: the Dow Jones Industrial Average (or Dow Average), which was fast closing in the 14000 mark. The Dow Jones Industrial Average includes large established companies such as Boeing, 3M, and Disney; companies that are often bellweathers for their various industries. For this reason, many people watch the Dow Average to get a sense of the direction of the overall stock market.

Round numbers, in this case 14000, tend to function as "pivot points"; points that either provide resistance to further price increases, or, once surpassed, serve to support to prices when they pull back to that level. This behavior, in both individual stocks and in market averages, was first observed by Jesse Livermore, an innovative speculator of the 1920s. The reasons for this behavior have their basis in human psychology - people tend to anchor their attention on numbers that are easy to remember, and to make decisions based on the performance of share prices relative to those anchors. The effect of this anchoring is to cause buy and sell orders to cluster around round numbers, making these levels difficult to pass through unless the momentum of the market is particularly strong. Another effect of this "anchoring" behavior is that the media trumpets the arrival of each new round number (first 12000, then 13000, then 14000), drawing attention to the performance of the stock market, and drawing in more buyers.

So, when a market average such as the Dow passes through 12000, and then 13000, confidence and buying momentum build. And when the next much heralded number, 14000, becomes a barrier that the market can reach, but that the Dow average cannot close above, then that is a worrisome sign for the stock market.

The stock market is certain to cross 14000 sooner or later, but for at least the time being, the market is taking a breather, and a close above 14000 is most likely weeks away, in the opinion of this humble scribe.

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