Chapter 3 The Trend is Your Friend
June 12th, 2008 | by Scott |In our last discussion of Bear Market Game Plan, we talked about not falling into the trap of listening to your emotions when investing in the stock market. How do you avoid your emotions? One way you is by learning the trends in the stock market and you also need to learn that the trend is your friend. Think of taking a raft down a river, if you find the right current the trip will be easy and won’t take much effort. Get in the wrong current and the trip can be choppy and dangerous. Ross Jardine says in his book the Bear Market Game Plan (Strategies for Success in Choppy Markets) that you have to know the current if you want your head to stay above the water.
To be successful in the stock market you have to know how to recognize the market trends. Check them on a daily basis. Jardine suggests that you use charts that show a daily moving average. He recommends 30 day or 50 charts. On a 30 day chart, it will show the market average for the past 30 days. You can then compare it to a daily chart. The daily chart will be choppy going up or down each day. The 30 day moving average will be a smoother line. When the market is going up, the daily chart will be above the moving average, if the trend changes and the daily starts to drop then it will drop below the moving average. By using a moving average, you won’t panic if there is a one or two day drop in the market. And it will show the trend the market is heading to so that you can make the right investing decisions.
The charts can also be broken down in the various sectors of the economy. So don’t just check the averages for the Dow Jones or the NASDAQ, but also look at your technology charts, energy charts, and other sectors. There are only three trends; up, down and sideways. Learn the trends, when they are bullish use bullish strategies. When they are showing the bear, use your strategies for riding out the bear. If you are not sure what to do, then follow the saying –when in doubt, sit out.
If you are a short term investor, then use the shorter daily averages. If you buy a stock and look to profit quickly use a 30 day moving average to determine the trends. If you are a long term investor then you are not worried about the short ups and downs, so look at a longer moving average, say 200 days. Even if your investing style is buy and hold, you want to make sure you understand the long term trends so that you don’t end up holding on to a stock for to long.
Don’t fight trends, when a stock approaches its moving average it tends to bounce away from the moving average in the direction of the trend on the moving average. In other words, if the daily chart is above the moving chart, it may start dropping but normally rebounds when it approaches the moving average. You should invest in stocks with an up trending short-term moving average, only invest when the technical indicators you follow give you a bullish signal, and/or invest only if there is no immediate resistance on the chart. More on Ross Jardine’s Game Plan for trends and Bear Markets in future installments.