If someone asked you today, “Is the stock market in an uptrend, downtrend, or a lateral consolidation,” what would you answer?
Knowing the answer to this key question is important for the stock market or even an individual stock. Why? If you buy a stock (go long) in an uptrend, you are more likely to make money on it.
Next, you will learn a simple way to see for yourself if the market is heading upwards or downwards.
First, let’s examine what types of trend exist:
Types of stock price trend:
- Uptrend: The stock or index is moving up, making new highs or higher highs
- Downtrend: The stock or index is moving downwards making lower lows
- Sideways consolidation: neither making significant new highs nor new lows
There are also time-frames to consider in evaluating a trend; for this, we will refer to Charles Dow’s classification.
Types of stock trend time-frames:
- Short Term: Days to weeks
- Medium Term: Weeks to months
- Long Term: Months to years
By combining the above terms, you could be specific about the market trend. For example, you could say the market is in a short term up-trend, but a long term down-trend. But isn’t that contradictory, the market being in both an uptrend and a downtrend at the same time?
Not really, it makes perfect sense.
Using moving averages to assess the market trend
We can use moving averages to help us easily assess if the market is in an up or downtrend and on what time frame. To do this, we need to set up three moving averages on a chart.
Setting up your stock chart
Set the Price to Logarithmic and one day per bar
- Add Moving Average 200 – White Dashed Line – this is the moving average of 200 days of price history
- Add Moving Average 100 – Orange Line – this is the moving average of 100 days of price history
- Add Moving Average 20 – Green Line – this is the moving average 20 days of price history
If the price is above the 200-day moving average, we can assume it is in a long term uptrend. Below the 200 days moving average, then it is in a long term downtrend. 200 days = 10 months = months to years’ time frame.
If the price is above the 100-day moving average, we can assume it is in a medium-term uptrend because it is above. 100 days = 5 months = weeks to months time frame.
The same goes for the 20-day moving average; this represents 20 days = days to weeks’ time frame.
So now you know how to evaluate a market trend using moving averages. You can also use this technique of a stock, commodity, or even FOREX charts.
Stock Market Trends Conclusion
Our conclusion for the state of the Stock Market (S&P500) in this 2011 example is:
Long Term Up-Trend
Medium Term Up-Trend – but this might change soon as the price is just crossing down through the 100-day moving average
Short Term Down-Trend as the price is below the 20 days moving average.
So the questions to ask yourself are:
- Do I want to buy into the stock market if it is in a short term down-trend?
- Do I want to buy into the market if it is in a medium-term and long term up-trend?
Also, do not forget, short term trends develop into medium-term trends which can develop into long-term trends.