A Simple Way to Identify a Stock Trend
Some things in life are complicated. Identifying a stock's trend is not.
Wall Street is littered with old market adages. These include:
- The Trend Is Your Friend
- Sell In May And Go Away
- When the last bear says "buy" it's time to sell.
- Even a dead cat will bounce if it's dropped from a high enough altitude.
- Troubled waters make for good fishing.
There's a lot of wisdom in these old adages, which is why they stick around. Today, we'll focus on #1 The Trend Is Your Friend.
The basic concept is that if you trade with the trend of a stock, you'll have some wind at your back.
Technical traders like to say there are 3 different kinds of trends:
Step 1: Use a Moving Average
- Bullish (rising prices)
- Bearish (falling prices)
- Neutral (sideways range)
How do you identify a trend? Pull up a stock chart. Go ahead do it right now. Any stock chart.
- Add a simple moving average to your chart. Choose a 20-day and a 50-day.
Moving averages are a simple indicator that easily show if a stock is in an uptrend or a downtrend and also turning points in trend.
Within technical analysis
, which includes some very subjective forms of looking at the market, moving averages offer an objective way to analyze a stock price and trend.
Step 2: Compare Moving Average Against Price
The basic concept is that if the stock price is above the 20-day moving average then the short-term trend is up (just flip that for a downtrend). If price is above the 50-day moving average, then the intermediate-term term trend is generally considered to be rising and bullish. Finally, the key line in the sand for stock trends is the 200-day moving average.
Step 3: Identify Buy and Sell Signals
- This 200-day moving average is considered a "proxy" for the long-term trend.
- Is the stock above its 200-day moving average? Then, the dominant or long-term trend is up.
- If the stock is below its 200-day moving average that would signal that the longer-term trend is down.
In very simple terms, moving averages offer a very basic "buy" and "sell" signal. However, it is worth knowing that moving averages, by the nature of their formula, will never get a trader out at a market top or in at the bottom of a trend. Moving averages are considered a "lagging" indicator. Instead, moving averages are valuable to capture the majority or about 3/4 of a market's move.
Here's how a moving average crossover buy and sell signal works.
Looking at the crossover strategy, we'll use the 20-day and the 50-day moving average.
When the shorter average (in this case the 20-day) crosses above the longer average, a buy signal emerges.
A sell signals forms in the opposite fashion, when the 20-day falls below the 50-day.
Let's be clear. Moving averages are not the Holy Grail. They are one indicator that can be utilized alongside a few others to provide insights and confirmation into a potential market move.
we analyze markets using a number of technical tools. The moving average is just one tool in our trading arsenal.
In trading, it is important to rely on the concept of confirmation. That simply means, the more technical indicators, which are flashing the same signal at the same time, increases the odds that a trading idea would be successful.
We use technical analysis to identify low-risk option trades to provide income. It's not as hard as it sounds. Come join us and listen to our live options trading room
. We put on new trades every week and show you how to do it to. Let's trade together!
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