If I was to ask 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.
If I was to show you a simple way to see for yourself if the market is heading upwards or downwards, would you be excited?
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 or new lows
There that was easy. Well not quite. There are also time-frames to consider. For this, I will refer to Charles Dow’s classification.
Types of stock price 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 uptrend, but a long-term downtrend. But isn’t that contradictory, the market being in both an uptrend and a downward trend 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 down trend 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 1 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 a long-term uptrend. Below, 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 is it 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 the theory lets look at the charts and draw our conclusion.
Stock Market Trends Conclusion
Our conclusion for the state of the Stock Market (S&P500) in June 2011 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-day 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 trend develop into medium-term trends which can develop into long-term trends.
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