Friday, December 28, 2007

Determining Market Trend

The trend is your friend, right? I am sure everyone has heard this adage and it is certainly true when it comes to trading. Trading from the correct side of the market is a very important factor in terms of the success rate of trades, whether short or long. I try to stick with the trend whenever possible - go long when the market is clearly in an uptrend, and short when the market is in a downtrend. It isn't always that easy, however - the market sometimes doesn't seem to know what it wants to do. Whatever you want to call it - market timing, market direction, market outlook - there is not a perfect system that I am aware of that can with 100% accuracy assess what the market is going to do next. The stock market is much too complex of an environment for one technique to be perfect all the time. Therefore, I use several strategies that I try to combine to give me an idea of what is going on currently and how I should trade based on that assessment.

#1 - Investor's Business Daily - The Big Picture

If you do not currently subscribe to this great resource, I would recommend it. If you haven't read any of William O'Neil's books on trading, (he is the founder of Investor's Business Daily) I would also recommend it. His system of assessing the market direction involves counting distribution days to look for tops and looking for follow-through days to signify a new rally beginning. In the "Big Picture" section of the paper, there are basically three conditions listed everyday - market in confirmed rally, market in correction, or market rally under pressure. By following this everyday, I get a good idea of the current state of the market. I don't always agree with the assessment, and the system is not 100% perfect, because there are sometimes failed follow-through days, but overall it is normally very accurate. In fact, I would like to do some backtesting at some point of how a very simple system of going long an ultra Proshares ETF when the market is in a confirmed rally and going long an inverse ultra Proshares ETF when the market is in a correction would do over a long period of time. There would be a few whipsaws, but I would bet that this type of system would be successful without a lot of work. Again, Investor's Business Daily is a great resource for market direction.

#2 - Stockbee Market Monitor

Another great resource useful for market direction is from the blog of Pradeep Bonde, Stockbee. I found this blog a year or so ago and it is a tremendous resource for traders. Using Telechart, he has developed a series of scans that keeps track of four or five ratios that help traders determine the underlying trend and anticipate near-term moves. Out of respect to him, I will not comment much more on these scans, but I encourage you to check out his website and learn for yourself. He also offers a subscription site for traders interested in learning more strategies including his Market Monitor. I keep track of theses ratios through Telechart on a daily basis and make many decisions based on the numbers I get. One gives a broad, overall indicator of the market, while others give shorter-term signals when the market is extended and due to pullback, or when the market has possibly put in a short-term bottom.

#3 - Investors Intelligence Survey

This survey is listed every Tuesday and charts the percentage of bulls in the market compared to the percentage of bears in the market on a weekly basis. This sentiment indicator is usually a contrary indicator, meaning that if there are a high percentage of bulls, that shows the possibility that most of the buyers of stock could already be in the market, and if that is true, how will the market continue to go up. A high percentage of bulls is therefore bearish, and vice versa if there is a high percentage of bears - that is bullish. This is a secondary indicator for me - I simply use it to confirm or contradict what I may be seeing in IBD or the Market Monitor.

#4 - Charts of the Indexes

The last method I use to keep track of market direction is to study the charts of the major indexes on a daily basis. By using Telechart, I also use a few of their customary indicators that
help me in this regard. As this blog progresses, I will attempt to post charts of the indexes several times a week to show what I see. By observing the price and volume action on a daily basis just like you would with an individual stock, you can learn a lot about what is going on in terms of market direction.

I know there are many other ways to determine market direction, and there is no doubt that traders have been successful with strategies much different than the ones I just described. For me, I have been using these four strategies and will continue to do so - they are not super complicated or cumbersome, and using them together, I believe they work pretty well. They are by no means perfect, and I still have to overcome some personal biases at times and trust what I see in these indicators, but I will continue to work and develop this system and hopefully improve it as time goes on. I believe successful traders always try to improve their methods, and I will do the same.

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