If we spoke a few days ago on our technical analysis blog about this method, why not illustrate it? We have chosen for this exemplification one of the most traded shares on planet Earth – the stocks of Microsoft.
Above is enclosed a chart created by doitinvest showing the evolution of the Microsoft stock / shares (blue) in parallel with the Dow Jones since the initial public listing of the company (1986) to present. Interestingly enough, this very long term graph (covering 12 years) shows a clear correlation between the Microsoft shares and the Dow Jones Industrial Average index. In the attached chart, you can notice that when Dow Jones raises, the Microsoft stock value raises too, whereas when DJIA decreases, the Microsoft stock quote tends to follow soon the trend.
This correlation trend between DJIA and Microsoft can actually be quite easily tested mathematically (this is why it is actually called “technical” analysis – it can be tested extensively through maths). The correlation coefficient measures if the direction of movement in the value of one set of values is correlated / goes into the same direction as another set of values.
The correlation coefficient between the Microsoft stock value (MSFT) and the Dow Jones average value of all the stocks is actually very high – 0,96. The closer it is to 1, the more the two values move in the same direction. In our particular case, this coefficient indicates that Microsoft shares will sink when the DJIA decreases – and they go up with the DJIA. From the graph this is quite clearly visible.
What lessons can be drawn from this technical analysis of the Microsoft stock? First of all, due to the high correlation coefficient, the investors should watch the DJIA moves which will very quickly translate into the Microsoft shares variations. In these days for example Microsoft stock has been very volatile, going up and down once with DJIA.
Secondly, as previously mentioned on doitinvest, the Microsoft shares are very cyclical, in that they follow the general trends of economy. This cyclicity of the MSFT stock makes it vulnerable to macroeconomic shocks but highly reccomended for purchase in periods of economic boom, since it will grow at the same speed as the economy.
Thirdly, for any portfolio the Microsoft stock is quite neutral – it is rather a portfolio in itself, not allowing any diversification. This means that over the long term the Microsoft stock will tend to overperform the DJIA, but not much, therefore it is a stock reccomended for prudent investors such as the risk averse individuals or the pension funds (which actully hold a big chunk of its stock).
Of course, as mentioned before on doitinvest.com this is a technical analysis and should be regarded as such – as a chart reading exercise rather than an in-depth prediction of the future Msft stock price. However, we hope you enjoyed this technical drill!