Modeling the Stock Current Market on 1987

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John Forman - The Essentials of Trading author

One of the things going around the market these days is the idea that the price action in the Dow this year is quite similar to the price action we saw during this same period back in 1987. Obviously, the implication there is we are headed for a major fall.

This sort of thing gets highlighted from time to time in the markets. Paul Tudor Jones is well known by those who were around during that time period for having taken very seriously an analog between the 1929 market collapse and what happened in 1986-1987. This is basically an evaluation of price patterns - a kind of technical analysis - but one needs to be cautious about the implementation.

Take a look at the chart below sent to me by a colleague (click for a larger view). It shows the performance of the DJIA during 1987 (left scale) and 2007 to-date (right scale).

On the face of it, once can certainly see some similarities on the way the index has performed lately and how it did twenty years ago.

Now take a look at this chart. It’s one I put together showing the normalized performance of the Dow for 2007 to-date and the same period in 1987. I started both indices at a base value of 100 so it would be easy to compare their relative performance.

This is a very different looking chart, isn’t it? In 1987 the market was very strongly trending higher - more than 40% to the August peak from the start of the year - while this year the market has been moving mostly sideways. That, to me, indicates two very different market situations. As such, it is of dubious merit to project anything for the current market based on what happened 20 years ago.

That’s the point I want to make. If you plan on doing comparissons in the market, make sure you are doing so on the right basis. You might be able to derive some interesting information by matching up two different market time periods, but only if you can do so with some common ground. Otherwise you’re talking apples and oranges.

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