When the stock market is all time high one important question that we should ask is, are the valuations high?
There to no one answer to this nor there is a direct answer.
Hence the entire analysis is divided into two parts first is the valuations and second is technical analysis. Let’s start with technical analysis
Technical analysis is a study of charts and those who study charts are often known as chartists. In Technical analysis it is believed that the stocks usually move in trends and price discounts everything. On the whole there are around 8 assumptions for technical analysis.
1# Assumption. The stock market has all the information factored into the price. And all the market is freely available in the stock market. This is the foremost and the most important assumption. Anyone thinking that this is not true would find difficult to believe in the technical analysis.
2# Assumption Technical analysis work only in stocks with high volumes. Illiquid stock or stock with very less trading volumes cannot be predictable. This leads us to the stock selection of only liquid stock. Many first time investors and traders with technical analysis fall into this trap and conclude that the technical analysis doe not work.
3# Assumption Stocks which deal with price movement with only demand and supply: fear and greed can be prediction can be made. Stock with “Artifical Price Change” impact the stocks technical analysis and should not be considered for analysis. Especially when the situation arises from dividends, bonus, stock splits and distribution of the stock.
Failing to ignore this vital points would only lead to wrong stock predictions.
4# Assumption News which can have an extreme impact on the price of the stock should not be considered as a good opportunity for investment based on technical analysis. Any political news, natural disaster news, high impact news should be avoided to invest or trade. Technical analysis cannot predict such sudden change in the flow of information regarding the stocks and situations.
5# Assumption There has always been a discussion on technical analysis is an art or science. My question to those who think it is science is, if the technical analysis was since then robot or black box trading, machine learning would have been way successful than others. But this never happens.
#6 Assumption Technical analysts believe that history repeats itself. Recording of various stock prices have been done which has lead to the conclusion that price of the stock that goes up has to come down and then the stock consolidates. After every consolidation of a stock for a certain period of time, the stock usually breaks out to news highs forming a higher top and higher bottom.
#7 Assumption Market has all the information already factored into the stock price. Hence no other information is required or should be considered. This situation puzzles most of the traders into wrong decision making.
#8 Assumption Technical analysis does not study the intrinsic value of the company before doing the analysis.
Based on the Technical Analysis it is a positive sign if the stocks are making higher tops and higher bottoms.
Now comes the second part which is the valuations.
There are various methods that one could use to find if the stock market is priced high or not. One of the most basic method is through Price to Earning ratio. It is usually said if the PE Ratio is more than 24 than one should be very selective in stock picking vice versa when the PE Ratio is around 15-18. During the time of high PE Ratio it is best to leave the stock picking to the professionals.
If the valuations are resonable and the stock market is all time high one can pick stocks. Perhaps if the valuations are very high and even the stock market is all time high one should be very selective in stock picking.