One of the reasons I like technical analysis is that there is so much to it that is logical.
Markets that go down get oversold. Markets that go up get overbought.
Markets that go down tend to get folks nervous and scared. Conversely, markets that go up tend to make them bullish and happy or giddy.
Pretty straight forward, right?
Even moving averages make sense because they give you the average price someone paid to own that security over a certain period of time, thus taking in the concept of "breakeven."
What about trend lines? Think of them as the growth rate. An uptrend line represents the rate at which the stock price has been growing while a downtrend line represents the rate at which it has been declining. Therefore, breaking that trend line represents a change in the growth (or deceleration) rate.
Breadth makes logical sense, too. The more stocks that are participating on the upside the easier it is to make money on the long side. The fewer stocks moving on the upside, the harder it is to find a winner.
But there is one aspect of technical analysis that defies logic. At least to me it does. And I can fully understand why some might call it voodoo when we start measuring targets.
Support and resistance make perfect sense, it's that "breakeven" concept. But measured targets? I have never seen a good explanation for why they work. And yet they do.
The concept is simple. We take the high of the pattern and subtract the low of the pattern. We then take that difference and add it on to the breakout or subtract it from the breakdown to get our measured target.
I just don't know why it works. More often than not, though, it does.
If we look at the S&P 500 from the last two years we see the high of the pattern was around 2920. The low was 2550. Subtract 2550 from 2920 and you get 370. Then you subtract 370 from the breakdown, which is when we broke the uptrend line, and you get 2380. And would you look at that: the low was 2350.
Many might ask why I don't use the blue line since it is flatter. I could have. I mean had the rally in the S&P stopped at 2600 (resistance) the new measured target would be around 2230. But the FIRST measured target was 2380. And the indicators were oversold with too much bearishness (the logical part of the equation!).
Consider this as we look at the chart of the yield on the 5-Year Treasury Note, below. That top measures to 2.15%. The blue triangle that formed in the first quarter of 2019 measures to 2.20%. I thought of this since despite all the hoopla and hysteria about bonds last week the yield on the 5-Year Note closed the week unchanged from the previous Friday.
Maybe it only rallies to 2.40% and then heads back down again and we need a new downside target (the same situation had the S&P failed at 2600 above) but right now I think this is the area that we should see yields make a stand.
Sometimes there is an overshoot or the target is just a way station but I'm in the camp that this 2.10%-2.20% area is enough for now. We've got sentiment on our side which also makes it logical to me.