Daily Gains Letter

Why May 22 Was So Important for the Key Stock Indices

By for Daily Gains Letter |

Why May 22 Was So Important for the Key Stock IndicesOne of the biggest mistakes an investor can make is trying to predict where the stock market will make a top or a bottom. This can cause severe damage to their portfolio, because they might be faced with losses if things don’t turn out as they had anticipated.

On Wednesday, May 22, the key stock indices showed interesting price action, to say the very least. Look at the chart of the Dow Jones Industrial Average below, paying close attention to the circled area.

Dow Jones Industrial Average

Chart courtesy of www.StockCharts.com

While testifying in front of the Joint Economic Committee to provide insight on monetary policy and the outlook of the U.S. economy, Federal Reserve chairman Ben Bernanke suggested that the central bank will continue with its quantitative easing—printing $85.0 billion a month and buying long-term government bonds and mortgage-backed securities (MBS). (Source: Chairman Bernanke, B.S., “The Economic Outlook,” Board of Governors of the Federal Reserve System web site, May 22, 2013, last accessed May 27, 2013.) As a result, the key stock indices rallied; the Dow Jones Industrial Average reached a new record-high of 15,542. The reason for this increase is that more money printed means a higher stock market due to the decline in value of the U.S. dollar.

Sadly, later that same day, the meeting minutes of the Federal Open Market Committee (FOMC) were released, with some of the members of the committee suggesting that quantitative easing should start to taper off as early as the next meeting, which is scheduled for June. (Source: Fontevecchia, A., “A Divided Fed: FOMC Minutes Reveal Hawks Calling For QE Taper In June,” Forbes, May 22, 2013.) This phenomenon caused the key stock indices to decline, ending the day in the negative.

What this sudden change in direction suggests is that buyers were exhausted and sellers took command. According to technical analysts, a candlestick pattern called the “shooting star” was formed—a pattern often associated with a top or peak in prices.

Considering the facts, should investors start selling their stock holdings and go short?

The answer is, no. It is too early to say if we have reached the top of the market and should jump to make investment decisions, so investors should avoid doing this. I’m not denying this isn’t significant; it may very well be the turning point. Investors should make a note of the highs made that day—they can act as resistance going forward.

Investors should also consider the price action of the day after the key stock indices formed a shooting star pattern. For example, on May 23, the Dow Jones Industrial Average opened low, and over the course of the day, it moved higher and erased almost all the losses, suggesting buyers are back.

Looking at it from an even broader perspective, the trend that began in January of this year is still in place. Remember: the trend is your friend—until it’s broken.

Once again, the price portrayed by the key stock indices on May 22 is just one of those situations where investors should consider taking some of their profits off the table. If this is not the market top and the trend continues on the upside, investors can still make some money—but going short can hurt them significantly.

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