Trading in the direction of the stock market trend
will give your trades POWER!
After placing a trade and watching the stock price fluctuate, do you sometimes feel like a tiny boat being tossed around in a stormy ocean or a cruise liner diverted from the storm and cruising in calm waters?
If you sometimes feel like the tiny boat, then the topic of how to determine the stock market trend will help to change that by giving you the ability to trade with more confidence.A trend is the direction that price is moving and will either be an uptrend, a downtrend or a sideways trend. The main point of looking at market trends is to buy into an upward trending market rather than a downward trending market - unless, of course, you are prepared to sell shares short. Either way, checking on the market's direction will give you a better chance at a gain rather than a loss. It’s a little like some turbo boost action on your trade if you're taking a long position and it's risk management if you can read when the market is going against you.
Some indicators that can help you to determine trend are:
- Average Directional Index (ADX)
- Options Equity Put/Call Ratio
Take a look at the two charts of the $NYSE index charts below and think about which market you would have preferred to be buying or selling into.
After looking at those two charts, you can see how important it is to know how to read market direction so you can decide when to get in and out of a position or even when to stay in cash.If you’re already in a position, a change of stock market trend can signal you toward the defensive side of trading and act as a warning to protect your gains and your capital by tightening your
stops.
If you're a longer term investor, rather than dollar-cost averaging by buying into stock positions at the same time each month, consider spending a few moments looking at market trend before increasing positions. If the market is trending downward, a strategy to try is to keep the monthly money in cash until the next month looking for signs of a trend reversal. After a few months, see if timing entries increases overall gains.
Here are some good and easy places to look for clear indications of market trend, whether you’re a long- or short-term investor. These things string together a pretty good picture of what's happening in the market. Click on any of the headings for a more detailed explanation and additional examples of the following:
Average Directional Index Indicator (ADX)
The average directional index (ADX) is the king of trend indicators and can absolutely work to determine trend. It gives a clear, easy-to-read picture of what is happening with the market by providing a value to trend strength and insight to whether a trend is strengthening or weakening.
This is the indicator I personally use to determine whether to enter long or short positions or to stand aside in cash. It also helps me to see if I should tighten my stops when trends begin to weaken.
The next two indicators, Moving Averages (MAs) and Parabolic SAR can help with determining trend or confirm a move.
Moving Average (MA)
Multiple moving average (MA) lines provide directional trending or non-trending lines that indicate trend when the price closes above or below a line or the lines cross. In the chart below the red line (20-day) MA and the blue line (50-day) MA are just about to cross signaling a confirmation of a down trend.
The moving average lines can be adjusted for however long you like to hold a position. If you're a long-term investor the moving average time periods can be 50-day and 200-day. Shorter term can be 10-day and 30-day. It's up to you to determine in your
trading plan
how you want to adjust your market trend information.
Parabolic SAR
Some easy ways to quickly get a sense of market trend is to use the Parabolic SAR which is identified by the blue dots on the chart. What you want to see is if they are below or above the price bars. If the dot is below the price bar it signals a trend upward. If above, it signals a downward movement.
Tip: If you dollar cost average, the Parabolic SAR can be the indicator you look as a signal to add more to your position or keep the money in cash until you see a positive signal. You can look at a weekly chart with Parabolic SAR too to get a smoother, longer-term view of trend.
Supplemental Guides
There are a couple of other things you can look at to help determine market direction is trader or market sentiment. Market sentiment is sometimes called “crowd psychology” as it relates to fear or complacency.
Two indexes that assist with this are the Advance-Decline Issues Index and CBOE Options Equity Put/Call Ratio Index. They simply give you an additional perspectives on what's happening in the markets.
$NYAD (NYSE Advance-Decline Issues) or $NAAD (Nasdaq Advance-Decline Issues)
Shows if more stocks are actually increasing or decreasing in value and advance/decline trend as in the example below of $NYAD (NYSE Advance-Decline Issues) where a negative shift began recently.
And lastly, a tool for helping gauge the future stock market trend is the $CPCE (CBOE Options Equity Put/Call Ratio). If this sounds intimidating, don't worry, it isn't, but if you find that it is more than you need or want to know that's ok. The other market trend indicators will serve you just fine.
$CPCE (CBOE Options Equity Put/Call Ratio)
Gives you a sense if people are feeling optimistic or pessimistic about the future of stocks based on put/call purchases (example below).
These easy to identify stock market trend methods can also be applied to individual stocks to determine their price trends.These are terrific ways to determine the general direction of a current stock market trend, and it’s knowledge that will help you to make smarter and
better trades.
These aren’t hard and fast signals to live by, but they do offer a legitimate view of what the markets are doing at any given time.
When you have a comfort level with determining the stock market trend you can move on to the next step of
finding the best stock to buy.
Move on to the next step in determining market trend - the king of trend, Average Directional Index (ADX).
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