Historically speaking, the volatility we’ve witnessed has not been normal. And after almost five years of below-average volatility levels, the past few weeks have felt even worse. Recently a closer look at volatility in U.S. equity markets was studied within a historical context.

Market Volatility Over The Century

The statisticians went as far back as 1900 to gather points of data on all instances when volatility significantly deviated from the historical long-term average (for you statistics gurus, that’s +/- 1 standard deviation from the norm). I’ll continue to refer to this anomaly as a “surge in volatility”.

As observed in the chart below, it is evidenced that aside from the past few weeks there have been four specific instances in history when we have seen an extreme surge in volatility – October 1929, February 1938, October 1974 and October 1987 (notice the frequency that the month of October occurs).

Based on a comparison of these historical periods, here are some observations:

•  The increase in volatility occurs very quickly.
•  In three out of four times, the market bottomed within one month after the initial surge in volatility (in ‘74, the market bottomed two months after the initial surge).
•  In all but one period, the stock market was up in the 12 and 24 month periods following the surge. The exception was the period following October 1929 which stands to reason given the extraordinary economic headwinds of the era (the Great Depression).

 What does this mean for investors?

If the chart is any indication, a surge in volatility may be one indication that we are seeing the “darkest before the dawn”. It’s very important to note that this analysis isn’t meant to signal that a market bottom is around the corner. Rather, it suggests that periods of extreme volatility like the one we’re experiencing today have tended to represent important turning points in the market.

Of course the standard disclosure always applies in that “past experience is no indication of future performance”, but my view is that history is all of the information that we have to analyze.  Therefore, I take the stance that this compilation of information is better than no information at all.

I suppose that only time will tell if the extreme volatility in the equity markets during October 2008 was yet another indication of a market reversal.  

Chart Courtesy RBC Capital Markets

First, let me tell you that there are many technical analysis strategies and indicators that traders use to make money in the stock market. In this post I will go through the basics of two distinct technical analysis strategies that are used to make money in the stock market.

1.)   Many technical analysis strategies are based on momentum. That’s right, forget buy low and sell high; buy what’s going up and sell it when it goes up more. This is what technical analysts refer to as buy high and sell higher.

One popular momentum based investing style, CANSLIM, was developed by Investors Business Daily founder William O’Neill. This strategy identifies companies with accelerating earnings and revenues, along with a strong market and increasing investor sentiment (more money managers and mutual funds buying the stock).

Let’s face it,  Economics 101 says that price is based on supply and demand.  That said,  and the average investor cannot move the price of a stock. Only the “Big money” such as mutual funds and pension funds can produce enough volume to significantly move the price of most stocks. You can learn more about CANLSIM at Investors Business Daily and see it used in real life over at Chris Perruna.com.

2)   Other strategies look for reversal patterns in the charts. Some technical analysts will watch for increasing volume and stabilizing or rising stock prices to signal the reversal of a downtrend.

In markets that are downward trending, technical analysts will use price and volume, along with other indicators, in an attempt to find the bottom of a downward price trend.

Traders watching for these reversal situations will also monitor the previous support and resistance areas.  If the stock has had previous support at a certain level, technical analysts will watch for that support to continue as the price drops to that level again. It is considered a Red flag when the price of a stock drops below its previous support level. 

I know that I have been very vague and brief in my descriptions of these strategies. However, I always found it easier to understand when the information was explained without the jargon.

I sincerely hope that this has helped you to understand a little more about some technical analysis indicators.  While I don’t use these to trade stocks, I do use some of these strategies to look for entry points to buy stocks that are already on my watch list for long-term buy and hold investment. 

 

As you can see by the 6-month chart, Encana (ECA) appears to have leveled off above support levels and is turning around on increased volume.
Encana Fundamentals
ROA – 15.97%
ROE - 38.08 %
Current Ratio – 0.99
Profit Margin – 46.8%

Encana’s dividend yield of 0.90% is above it’s 5-year average yield of 0.70% and have recently increased the dividend rate to $0.40 from $0.30 per share.

Please do your own due diligence.

Indeed, any time a stock rebounds from its 10-week or 50-day moving average, it can be just as opportune a time to buy as when it breaks out of a base. Or, it can be a good spot to buy additional shares.A little while after a leading stock breaks out of a base, it will often throttle back. That pullback often occurs at the 10-week average.

If the stock remains strong, it will rebound from that line.

Institutional investors like to buy stocks at a lower average cost, adding shares at key junctures such as when the stock hits its 10-week. That’s why a bounce back from the average is called “finding support”: institutions support the stock by buying more shares.

Look for stocks making their first or second pullbacks to the 10-week line after their initial breakouts. Third and subsequent pullbacks are riskier because the stock has probably extended itself too much.

Read on

It opened this morning, October 26, two weeks later at $53.01 USD. This is significant because it closed yesterday above it’s previous high.

Where technical analysis is concerned, a close above the previous high on large volume would indicate that there is little in the way of overhead resistance and the sentiment for a higher stock price is evident.

Southern Peru Copper has been making its gains in recent weeks on average volume. It would be prudent, in my opinion, to watch for the stock to close at a new high on volume significantly greater than the average volume. If the stock were to close significantly lower on larger than average volume, this would indicate a red flag and possible profit taking.

What are your thoughts on Southern Peru Copper?

Feel free to leave a comment and let me know if you think I’m off my rocker!