The Truth Behind Market Jargon
By David Wilson
Princeton, New Jersey, Oct. 16 (Bloomberg) -- Friday's rally in U.S. stocks recalled what may be the most gruesome cliche used to describe market moves: ``dead-cat bounce.''
Just picture it. Someone carries a cat that's died -- for reasons unknown -- all the way up to the roof of a building. The person stops at the roof's edge, throws down the formerly frisky feline, and sees what happens.
When the cat reaches the ground, it doesn't come to rest immediately, especially if it hits a sidewalk or road. Instead, the force of the descent causes the lifeless body to rise, just for a instant.
The analogy between the cat and stock prices came to mind because Friday ended the sixth straight week of declines for the Dow Jones Industrial Average, the Standard & Poor's 500 Index and the Nasdaq Composite Index. The losing streaks are the longest in more than a decade.
People who use the phrase are expressing the view that the day's gains -- including the Nasdaq Composite's 7.9 percent surge, the second-largest ever -- will soon give way to further declines, just as the cat's bounce proves short-lived.
Two other phrases are also likely to surface time and again in reference to the market's slide: ``oversold,'' often followed by ``condition,'' and ``support,'' often followed by ``level.'' It's worth delving into what's behind them.
Tests of Strength
When analysts refer to a market as oversold, they mean that stocks are poised to rebound simply because they have fallen too far, and too fast.
Analysts can choose from a multitude of indicators to reach this conclusion, and usually combine several of them. One that's popular with users of the Bloomberg Professional service is the relative strength index, or RSI for short.
To understand how the index works, consider what happened to the S&P 500 during Thursday's market retreat. The average peaked at 1366.63 in early trading, dropped to 1328.06 late in the day, and closed at 1329.78.
Now, with percentages, put these numbers in the context of the average's 46.87-point swing that day. The high reflects 100 percent of the move, and the low captures 0 percent. The close, just 1.72 points above the low, has 3.7 percent -- the day's relative strength reading.
Index calculations typically incorporate several days' worth of readings, and represent an average. Numbers below 30 suggest a rebound will come soon. For the S&P 500, the 14-day index reading was 20.3 at Thursday's close. It ended the week at 36.6.
Looking to History
Support is all about past performance, too. It's the analyst equivalent of drawing a line in the sand and then daring someone to step over the line.
By examining how an index has fluctuated, analysts can come up with a value -- in other words, a level -- at which investors may view stocks as a bargain and step up their buying.
On Feb. 28, for instance, the S&P 500 retreated to a four- month low of 1325.02 during the day. Four weeks later, the index was 17.2 percent higher.
Assuming that the prospects for stocks haven't completely changed, it's possible they may rise anew if the index drops as low as it did before. At least that's the kind of thinking that would go into setting 1325 as a support level.
More recently, the average dropped as low as 10,014.24 in Friday's trading before turning higher. That's just above 10,000, a convenient round number for anyone who wants to determine where investors may give stocks some financial support.
And what happens if the average falls below that level and keeps on going? Analysts come up with the equivalent of another line, just as people do in the sand.
Exactly the Opposite
In fact, a ``support level'' sometimes becomes a ``resistance level,'' or an index value at which investors may accelerate their selling because they view stocks as too expensive.
As an illustration, consider what happened after the S&P 500 jumped from a low of 1413.89 in late July to a high of 1530.09 on the first day of September.
After retreating all the way to 1419.44, the index rose at the end of the month. It couldn't move any higher than 1461.64, though, and drifted between the two levels at the beginning of October before retreating. So while stocks might have appeared cheap at 1420 or so before, the opposite may be true now.
Oversold also has an opposite: overbought, a term used to describe a market that's poised to fall because investors have been unusually quick to buy.
March marked the last time that the term fit the U.S. stock market, based by the S&P 500's 14-day relative strength readings. Numbers higher than 70 point toward a decline, and the RSI just barely crossed that threshold.
Considering how much lower it is now, analysts might be able to steer away from animal cruelty in describing where they expect stocks to move. That said, anyone following markets isn't likely to have heard the last of dead cats.
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