Shapes of Things to Come?

Do investors respond to certain “price patterns” that can be discerned from the past? In other words, can a stock’s price chart provide hints of how the stock is going to trade in the future?

Technical analysts think the answer is yes. They’ve established an extensive lexicon to describe these patterns—“head and shoulders top,” “support levels,” “cup and handle,” “inverse saucer.” Skeptics of this approach to market analysis think it’s akin to trying to deduce the future from chicken scratches in the sand.

But Chris Dvorak thinks technical research should be used in conjunction with fundamental research to get the best results. Dvorak has been studying charts since 1982. He spent 19 years at Perkins Capital Management in Wayzata, where he became the firm’s chief technical analyst. In August 2008, he started his own company, Minneapolis-based Dvorak Technical Research. We talked about charts in early June.

This market recorded in May what one research firm called one of the most rapid and dramatic free falls since 1950. Do you think it was oversold? In other words, did it express a lot of sheer panic? 

Dvorak: Absolutely. It came down a little faster and a little harder than normal. I have a couple of examples that are somewhat similar. In 1989, there was a mini-crash in October, and that took the market down 7.5 percent in four days; and then 16 days later, the market started to rally again. Then in 1998, from July 20 through August 31, the market was down about 25 percent in about 30 trading days.

So we’ve seen this before. Were the conditions then as tough as they are now?

Dvorak: I would say we are in uncertain economic times. But when I look at my chart, I see a very clear positive trend.

What gives you that feeling?

Dvorak: The S&P 500 got to about 1,040 at the end of August last year, and that high has defined all the lows since then. So the market has moved higher, and now it’s come back to this level. So it’s been somewhat of an internal correction, if you will. It has moved and come back and rested on this level for many months. I see that as very bullish because the correction is already over; this is sort of the ‘last crash’ before it moves higher.