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Hey, tradeologists. Today we are going to talk about technical analysis. Even though I don’t put a large emphasis on picking market direction, that does not mean that I don’t want to keep track of the market, and try to at least understand where it’s going. That will help me determine how to manage my risk.
I think it’s actually a pretty critical component of trading successfully. I wouldn’t suggest that it’s something that you can do without. I think you really need to pay attention to where prices are going. Remember, there are 4 risks in this business, but the obvious risk is price. If there was no price risk at all, then we could simply put on our trades, collect our Theta decay, and we would make money every single month, without any risk.
Price is the risk that we manage. In order to do it successfully, we need to have an understanding of where prices have come from, and where they are going, potentially. What we are trying to do is determine the highest probability of where prices are headed.
To get started, what I usually do is I take some very long-term charts on the Dow Jones Industrial Average. I also take a look at other long-term charts of the major averages, like the SMP 500, the Wiltshire Index, or the IWM, the Wiltshire 2000 or the 5000. Normally, I like to start with the Dow Jones Industrial Average, because it is the oldest index that we have available, to give us some information.
If you take a look at this, this is a pretty unbelievable chart. It is unbelievable, where we have come from. I started the chart back in 1923, here. You can see the 1929 crash here. It looks like a little tiny blip. It doesn’t look like much at all, does it? Historically, it was a big deal. It was an unbelievable percentage drop in the Dow Jones Industrial Average. But when you look at it, it looks pretty small.
Let’s zoom in on that for a second and see what we can see. Back in 1929, in the month of September, prices hit a high of about 380. They dropped off dramatically over the next few years, but these two months, in particular, are the worst months possible. It went from 380 down to 240, almost a 33% decline in prices.
Does this look familiar? It looks very familiar. We have had a lot of different price movements like this, over the last 80 years. This is not unusual at all for us to take a look at, because this is how prices move. They move up, and they move down.
Like I said, I don’t like to predict price, but not knowing the risk of price is a very dangerous thing. There’s only a couple of things that you really need to know about price, and some technical analysis tools, that I am going to give you in this video. You really should have a very good understanding of those tools. They are very simple.
Let’s zoom back out again, and see what else we can see. Back in 1926, there was a huge run up in prices. You can see how exuberant these prices are. Previous to that, the high was right around 110, on the Dow Jones Industrial Average. It broke through here, and it just kept going straight up.
The fall was even more dramatic, at that point. Not only did it come back to the 110 level, but it broke through that, all the way down to 40, back in 1932. Was there another period recently in our history, where prices like this occurred? Of course.
Let’s take a close look here. Prices didn’t go down as dramatically in terms of prices, but from 2000, we had a pretty dramatic rise, here. We broke through this level, where I have this channel. This channel goes all the way back to 1932. Here – this date is February 1, 1995. You have a channel that went back to 1932, that had not been broken, and it broke in 1995.
That was only 13 years ago. Look at the kind of run we had, from 1995, all the way to 2000. That was a pretty dramatic increase in prices. Then it backed off, and it did fall, but it never went below that level here, that it broke out at, back down to 4,500.
This declined, as we saw, over the next couple of years, from 2000-2003. It was relatively mild, as compared to the decline that we saw back in 1929. Were there other periods where we had a dramatic decline? Yeah.
We can go back here, to October 1987, where again, we had a tremendous run up in prices. That run up in prices was met with some resistance, in the 2,700 level. Prices dropped off dramatically from there.
That was a pretty big move, at the time – going from 2650 down to 2000. That was over a 500-point move. It was very dramatic. But look what happened. Prices continued to go up. In fact, we surpassed that 2700 mark, broke through that, came back down, and started back up again.
There is an important lesson here, in taking a look at these past run-ups, and subsequent price declines, after these huge run-ups. I’m sure you can tell what that is. The fact is, whenever prices become exuberant – in other words, they go up in extreme price movements, compared to the level that they were – then there is always the potential for a dramatic sell-off.
That happened here, in 1929. Here’s another tremendous run-up, from 1935-1936. Look at the sell-off there. Here’s another one – although the price run-up wasn’t quite as dramatic, it did back down, and start to go back into a trading range. That was in 1946.
Here is some more of a run-up, but it’s a little bit more moderate. It’s not as exuberant. We had a little bit of an up-and-down market for quite a few years here, from 1950-1954, until it finally broke out here, in the beginning of 1954. Again, we had a very exuberant upward trend in prices, that was met with some resistance, and started backing off again.
What happened? Prices recovered, and they went up again. Then they started to fall, and then they went up. Then they fell, and then they went up. You can see that this pattern repeats itself over and over again.
Now, this period here is very interesting. From 1966’s high, which was right around 1000, all the way… The breakout didn’t occur until 1983. From 1966-1983, prices were basically in a sideways pattern. That’s 17 years of sideways action.
We had a number of different rallies, and we had some declines. We had some rallies, and we had some declines. But for 17 years, prices basically didn’t do anything. Look what happened.