Always try to invest with the trend. Doing so is like paddling a boat downstream. Making progress is easy. It is very difficult to make progress when you paddle upstream. How do you determine what the trend is? If the 200-day average of the market index is rising, then the general trend is up. Does that mean the short-seller cannot sell short? It does not mean that at all. We do not define the trend by using only one measurement. For the person who buys and holds his positions for two years, a long-term rising average is favorable. However, for a swing trader who holds his positions from one day to a few weeks, that average will likely be irrelevant. That is why the trend indicator must fit the time-horizon (the intended holding period) of the investor.
If you intend to hold your stock for a week or so, then the direction of the 20-day moving average will be important to you. It will be of little or no importance to the individual who intends to keep his positions for two years. If you intend to hold for a month or more, then the direction of the 50-day moving average will be very important to you. However, there is some overlap here. The direction of the 50-day moving average can also be important to the swing trader. If the swing trader sees that both the 20-day and the 50-day moving averages are rising, he will have more confidence than if the 20-day moving average is rising but the 50-day moving average is still declining. Under the latter condition, he might want to have tighter stops and to sell more quickly at the first sign of weakness. If the two moving averages are rising, he might be a little more patient with his positions.
We have said that the trader should invest with the trend, but there is more than one trend to consider. There is the trend of the stock and the trend of the market. Assume a person is a relatively long-term swing trader who likes to capture moves that last about a month. It is possible for a stock to have a strongly rising 50-day moving average while the market index has a declining 50-day moving average. Of course it is better if both are moving in the same direction as the trade you wish to make. However, there are times when an individual stock will persist in a strong up-trend against the market’s direction. When a downward trending market has a rally, stocks with persistent strength will tend to rally as well. When the market has its next plunge, the stock in a persistently strong rising trend will tend to decline to its rising trendline. When it reaches that trendline, the savvy trader will monitor its behavior. If the stock shows signs of rebounding off that trendline, the trader will buy. In doing so, he is investing with the trend of the stock even though it is against the trend of the market. The fact that the stock is in a persistently strong rising trend is what makes the trade sensible. Expert traders often consider a stock’s return to its rapidly rising moving average to be one of their favorite “setup” patterns.
Accomplished traders try to monitor the general tone or “health” of the market by reviewing a series of indicators. However, there are useful observations the reader can make without referring to indicators. For example, if the market goes up on good news, the market is behaving well. If it goes down on good news, there is probably no trend in your favor, and bullish investments involve much greater risk. The point is that it is always a good idea to invest with the trend that is suitable for your investment time-horizon. It helps if the market is moving in the same direction as the most appropriate trend for your intended stock investment. In other words, if you are a short- to intermediate-term trader, and the stock you want to invest in has a declining 30-day moving average, you should take that as a danger signal. If the 30-day moving average is rising, that would be a good sign. If the 30-day moving average of the market is also rising, that would be even better.
Copyright 2013, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com