How to Trade Psychological Milestones

In the last couple of months, both the Dow Jones Industrial Average (DJIA) and S&P 500 Index (SPX), the two primary broad market indexes, have overtaken their all-time highs. However, potential resistance in the form of ultra-even levels sit just overhead. Specifically, the Dow is nearing 40,000, while the S&P 500 sits just below 5,000. These psychologically significant levels can influence investor sentiment, with perceived notions of an index being either "cheap" or "expensive." As such, they serve as popular points for buying or profit-taking. In this article, I’ll look at what has happened in the past as the indexes have approached these ultra-even levels --10,000 increments on the Dow and 1,000 increments on the S&P 500.

Behind the S&P 500 and the 5,000 Mark

As the S&P 500 closes in on 5,000, I’m looking at how the index has performed after hitting a 1,000-point increment from below. Specifically, a signal is generated when the intraday high is above the level after being below it for the previous 21 trading days (one month). The table below summarizes the returns following the signals. Based on the numbers, investors may consider these levels as hurdles cleared generating a buy signal for stocks. The S&P 500 has been strong after overtaking these levels, averaging a 1% return over the next week with 83% of the returns positive. The typical one-week return for the index since 1998 has been a 0.16% return with 57% of the returns positive. Over the following three months after overtaking one of these levels, it gained on average 4% with 83% positive, compared to the typical return of 1.8% with a 66% chance of being positive.

How the Dow Performs After Hitting 40,000

I did the same analysis with the Dow, showing how the index performed after touching even 10,000-point intervals. There were seven signals, and the results are a bit different than the S&P 500 signals. The short-term signals were poor with the Dow averaging a 0.7% loss over the next week, after touching the level with just one of the seven returns positive. Once you get farther out after a signal, however, the returns were bullish compared to typical Dow returns since 1998.

Finally, in the tables above, the returns can include multiple returns for each level in the case when it moves back below the level for at least a month straight, then crosses back above the level. I wanted to see if anything jumps out in the data if you only consider the first time hitting that level as will be the case when (and if) the Dow touches 40,000 and the S&P 500 touches 5,000. The tables below show each of the signals when the indexes hit the ultra-even levels for the first time. There aren’t enough data points to come to a strong conclusion, but the returns below look like the ones above. The returns for the S&P 500 outperform while the returns for the Dow underperform in the short term while outperforming in the longer term. The good news is that based on the data, these even levels haven’t acted as resistance in the past.