Here Bill Poulos explains how to identify and use stock market index trends to make educated trades. Bill is the President and Cofounder of Profits Run. He cofounded the company with his son Gregory and is a veteran investor. He has been analyzing the markets since the 70s. Poulos is also published author. Bill has written multiple books and training programs on options trading. Bill was born and raised in Detroit, Michigan. He still resides in Michigan with his wife. Together they have three children, all of which are boys. He is currently planning an event to introduce inner city kids to successful entrepreneurs to help give them inspiration and positive role models. See fightforhope.com for more details.
One of the most important things we can do with our investing is to look at the general market directions to decide if we are bullish or bearish. A bullish market is where investors will look to invest by buying stocks and a bearish market is where they will look to short stocks or close out of trades they currently own.
An important tool that we have in helping us determine the direction the markets are moving are the stock market indexes. A stock market index is a way to measure the value of part of a country’s stock market. This can be done by taking a weighted average of a select number of stocks or it can be calculated by simply summing up the prices of individual stocks. Knowing of these indexes can help investors be able to review and analyze how that specific market is performing. It can also allow for investors to see how one country’s stocks are performing against another.
While there are many different indexes and subsets of those indexes, below are some of the more commonly looked at and talked about indexes.
Dow Jones Industrial Average (USA) — A US stock market index that tracks the movement of 30 large public companies and how they have traded during a trading session.
DAX (Germany) — This is a German index that tracks the 30 major German companies that are traded on the Frankfurt Stock Exchange.
Hang Seng (Hong Kong) — An index of stocks traded on the Hong Kong Stock Exchange and is made up of 50 of the biggest stocks on the exchange.
FTSE 100 (London) — This index represents 100 of the highest market capitalized stocks traded on the London Stock Exchange.
Nikkei 225 (Japan) — Traded on the Tokyo Stock Exchange, this index tracks 225 of the top stocks trades on this exchange in some 35 different industry groups.
The Global Dow (World) — A 150 stock index consisting of stocks from about 25 counties around the globe but with a majority of stocks coming from the USA.
As we look at an index to help us with our technical evaluations of the strength or weakness of the stock market, we can see the direction we should be placing our trades. While most investors are looking for bullish markets to trade in, it is just as important to know when not to be buying or maybe more important, knowing when to exit trades we are in. In doing this, there are a couple of important elements that we need to analyze to know how a market is performing. These elements are the trend and support, or the resistance.
In our example, we will look at the Dow Jones Industrial Average to illustrate these elements. The first thing we want to analyze is the trend of the market. The old saying, “trade with the trend” is and important concept to understand. The idea is to trade in the direction prices are moving because they are likely to continue in that direction for the time being. While trends change, they usually do so over a longer time period which allows us to exit at the most appropriate time.
So, how do we identify the trend of an index? While there are multiple ways this can be done, there is one simple way to see quickly where the trend is moving. That way is to apply a 100 period Simple Moving Average and then look at the direction it is heading. If the line is moving up, the trend is bullish but if the line is moving down, the trend is bearish.
Let’s look at this concept on the weekly chart of the Dow Jones Industrial Average.
Notice how the red 100 period Simple Moving Average has been moving up since 2011.
This suggests that since that time, the US stock market has been very strong. While we have seen some minor pull backs in this trend, the overall movement has been very bullish. Knowing that this has been true since 2011, we would have done well by purchasing stocks in this type of market conditions. We also, understand that this trend won’t likely continue forever, but until we see it change we will continue to look for opportunities to buy stocks at the appropriate times.
The second element that we can see in the charts of the indexes is when prices are sitting near the areas of support. This is important because buying at support when the trend is moving up will give us the greatest opportunities to catch some of the bigger moves. As prices pull back in the opposite direction of the trend, they will eventually run into areas of support. As the price sits near these support areas, we will want to look for price to begin moving back in the direction of the trend so we can look to purchase stocks.
Finally, as we look at the strength or weakness that is shown in the charts of the indexes, we can get a good idea for how strong the market is for that particular country. When we have evaluated the trend and where support or resistance is located, we can know better which direction to trade as well as when the best times to enter those trades may be.
Take some time to look at these indexes to begin to see how they might help you in making your decisions to buy or sell your stocks.