Opinion: Dow 20,000 watch: There’s Some Truth to Psychological Hurdles

Posted by jbrumley on December 29, 2016 10:04 AM
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Look at how the Dow Jones Industrial Average is behaving compared with the Wilshire 5000 index

By Mark Hulbert, MarketWatch

Welcome to day 10 in the Dow’s so-far unsuccessful attempt to eclipse the 20,000 barrier (as judged by when this benchmark first traded within 1% of that level).

Many are wondering why the Dow industrials decided to pause here, given its extraordinary strength over the prior six weeks—and just as it was on the brink of this long-anticipated accomplishment.

In fact, however, there’s no mystery.

That’s because the market often hesitates as it approaches psychologically important hurdles like eclipsing 20,000. And it’s not just an after-the-fact rationalization of recent sluggishness for me to point this out. Academic studies from as long ago as two decades ago had already identified the behavioral trait of investors that lead to this phenomenon.

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Consider a 1993 published in the Journal of Financial and Quantitative Analysis, entitled “Price Barriers in the Dow Jones Industrial Average.” The authors are Glen Donaldson of the University of British Columbia in Vancouver and Harold Kim, who at the time was at Princeton University.

The two researchers devised a test to show how investors behave at times like now. If indeed it is the case that Dow levels containing lots of zeros represent psychological barriers, then the market’s behavior when it approaches them should be different than its behavior when it is far above or below them.

And that’s exactly what they found: As the market approaches a multi-zero barrier, the pace of its advance tends to slow. And when the market finally surpasses the barrier, its short-term pace tends to speed up. In technicians’ parlance, multi-zero Dow levels represent resistance and support levels.

Or, as Sam Stovall, CFRA’s chief investment strategist, put it this way earlier this week to clients: “Millennium and century marks on major stock indices have traditionally acted like rusty doors, requiring several attempts before finally swinging open.”

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To confirm their finding, the two academics examined the market’s behavior whenever a less widely followed index approached multi-zero barriers. They chose the Wilshire 5000 index on the theory that few investors are even aware of that index’s level. (That seems like a safe assumption; how many of you that it recently was trading at 23,475?)

They found nothing unusual about the market’s behavior in the vicinity of multi-zero levels of the Wilshire 5000. This finding reinforced the researchers’ belief that it is the psychological perception of price barriers that is creating those barriers.

So don’t be surprised if the Dow takes even a few days more before finally rising above 20,000.

Courtesy of http://www.marketwatch.com/MarketWatch

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