One of my first blogs ever posted was entitled: Pricing “the market” and Establishing Action Zones. That blog explains the logic behind the Action Zone – an area in which the Dow Jones Industrial Average should trade. The purpose of the Action Zone is to help investors determine how “the market” is valued based on historical performance. In other words, it’s a mechanism to help investors gauge whether stocks are overvalued or undervalued – or put yet another way, whether it’s a good time to buy or sell stocks.
Here is how the Dow performed within the Action Zone during the last twelve months based on my calculations in the aforementioned blog.
The green line in the middle is the action zone Midpoint, a point where stocks can be considered “fairly valued.” Anything above that point can be considered “over-valued,” while anything below it can be figured to be “under-valued.”
This is not to say that periods of “irrational exuberance” (like the housing boom) won’t propel the DJIA well beyond the action zone high watermark. And it’s also not to say that times of panic (like the crash of 2008) won’t cause the Dow to plummet well below the action zone bottom. Remember, the stock market is free to run wild on speculation and overreact to everything. It routinely does so. That’s part of the game. And that’s okay.
Investing is not about buying at the highest and selling at the lowest. It’s about making money – about buying low and selling high. And the best way to do that is to know where you are in the trading zone and to pick a spot to act that suits your objectvies best.
I hope this blog helps you understand where stocks stand.