Sherif El-Swefi* analyses current stock market conditions and offers an emergency prescription for survival It was a hectic, dare I say shocking week on Wall Street as investors watched all major indices take a freefall right before their eyes, starting Monday with Leham Brothers filing for Chapter 11 bankruptcy. The news rocked investor confidence the world over and sent the leaders of other major financial institutions to the bargaining table. This momentous week brought news such as Bank of America's acquisition of Merrill Lynch, while other major investment banks including Morgan Stanley were also considering deals of their own, in a bid to fix some of their deepening problems. As if all this carnage were not sufficient, news of the near-bankrupt American International Group (AIG) emerged, effectively spoiling what remained of the broth. As it happened, the United States' Federal Reserve came to the rescue of the sinking AIG, and by Wednesday, when it seemed as though nothing would stop the sell-off, billions of dollars dedicated to various bailout plans combined with changes in the rules defining short- selling eventually sufficed to put an end to the decline. Nevertheless, the market's volatility has truly been historic. The Dow Jones industrial average notched triple-digit moves each day. For many, the question is becoming whether bailout efforts which caused an impressive rally on Thursday and Friday will be sufficient to fight off a long-term move depression. The fact that the major indices are trading below the long-term resistance of their respective 200-day moving averages suggests that much work still needs to be done if there still is any hope for the current downtrend to end. "The concepts of support, resistance and pivot points have become such widely accepted market concepts that it is amazing to see how every book on the market mentions them freely, as though the reader is supposed to know what they mean and how they should be traded," said Hani Saad, derivatives and equities trader at the Royal Bank of Canada. To clarify, the support level is the price level below which a stock has historically had difficulty falling. It is thought of as the level at which many buyers tend to enter the stock market. Meanwhile, the resistance level is that where the given stock or market stops rising because sellers start to outnumber buyers. A question springs to mind regarding the application of these concepts to indices. It is not uncommon nowadays to hear, for instance that the S&P500 hit a major support, or pivot point, and that it should be watched very closely, for were it to break it would signal the start of the bear market, or long-term market pessimism and decrease in investment prices. Now, if one considers that the S&P is made up of 500 companies, and that these 500 companies each has its own support and resistance levels that are tradable in the same manner as the index, that does not mean that the S&P500 index resistance and support levels really reflect anything at all independent of those companies. In fact, they only represent arbitrary numbers made up of their components. Hence the main premise of pivots, support and resistance levels are a faulty concept. To illustrate, if we take the extreme case whereby all 500 companies are trading at a support level, this does not necessarily mean by definition that the representative index is trading at a support level on the chart. It can be trading at one arbitrary point on the chart with no significance to a chartist. Yet, this point is indirectly significant since it represents a collective support, as all the 500 companies are at a support level. The other extreme case would be where none of the companies is trading at a support level but the S&P is trading at what chartists call a support. In this case, what is the significance of the index's support level, or pivot point, if all the index components are trading at the more fluid level of no support? The conclusion is that we would be pretty hard pressed to try and reach market rock-bottom, or for the support level to bounce prices off. In periods of high volatility the bands necessarily widen, and stocks can end up being traded above or below their upper or lower bands. For example if stock X's original support level is five and resistance level is 10, so in periods of high volatility stock X's trading range could below five and above 10. The question remains as to how one can profit from current market conditions. The pressure has undoubtedly been in the downward direction. From a technical perspective, one will notice a series of lower highs and lower lows. These descending lines are used by traders to signal a down-trending market, and most would not expect this trend to reverse until prices are able to close above the recent high. From my point of view the only way to survive this market in its current condition is to trade it short by buying the dips and selling the rallies. * The writer is head of Technical Analysis at Delta Rasmala.
