If someone asked you today, “Is the stock market in an uptrend, downtrend or a lateral consolidation”, what would you answer?
Why is Knowing the Trend & Direction Important?
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.
Types of Market Trend
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 down 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.
Key Moving Averages To Use
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 in a long term up trend. Below the 200 day 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 is it above 100 day = 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
Short Term Down-Trend as 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 trends develop into medium term trends which can develop into long-term trends.