The stock trader who works a full time job must make the best use of limited time, typically in the evening and often taken away from time with family or other enjoyable pursuits. A previous article discussed stock chart research. Another task for the part time trader is to study the overall market, assess what is happening, and use this (in conjunction with other factors) to determine what types of trades to place.
Why is Market Direction Important to Assess?
For the part time trader who trades individual stocks, and who watches those stocks according to the practice of technical analysis, the benefit to overall market direction assessment may not be immediately obvious. However, there are good reasons for the trader in individual stocks to assess market direction.
- At least 70% of all stocks move in the same direction as the overall market.
- The beginning or ending of a stock’s trend will likely coincide with the market (at one end of the trend or the other.
- The trader can fine-tune the individual stock trade once a change in overall market sentiment is evident.
- Overall market direction can be used for scaling in and out of trades.
How Can Overall Stock Market Direction be Assessed?
Several financial organizations have developed “indexes”—groups of stocks that are somehow related and are tracked over time. The most famous of these is the Dow Jones Industrial Average, which is thirty large stocks. Others that most often make the news headlines are the NASDAQ indexes and the Standard & Poors Indexes. The following is a broader list of indexes that can be used together to look for changes or continuation of market direction.
- S&P 100 – the 100 largest publically traded companies in the USA
- S&P 500 – the 500 largest publically traded companies in the USA
- S&P 600 – an index of 600 smaller stocks
- Russell 1000
- Russell 2000
- Russell 3000
- Dow Jones 30 Industrials
- Dow Jones Transportation
- Dow Jones Utilities
- NASDAQ Composite
- NASDAQ 100
Sample Market Direction Assessment From June 15, 2010
To show how market direction assessment can be done, charts from June 15, 2010 are attached as figures. These are: the S&P 500, the Dow Jones Industrial, the Russell 2000, and the NASDAQ Composite.
Figure 1 is the S&P 500, a six month chart showing daily prices displayed as “candlesticks”. The last month the index has remained in a narrow range, between 1105 and 1040, as shown by the trend lines in the area marked with an oval. On June 15, 2010, the stock broke above the upper boundary of this range (the point of resistance), and closed at 1115, or about 1 percent above the recent highs. This appears to be a sign that the overall market, as measured by this particular index, has now broken out of the range.
Investors may have changed their sentiment and believe that the market will move higher, putting more money into the market. One index is not enough. Look at Figures 2, 3, and 4, which show the other indexes being evaluated in this example. Figure 2, the Dow Jones Industrial index, shows the same breakout pattern, even stronger than the S&P. However, the Russell 2000 and the NASDAQ Composite, shown in Figures 3 and 4 respectively, do not show the same breakout pattern. Rather, they closed right at the upper end of the recent narrow trading range, but both were up a good amount on the day.
This assessment indicates strength in the overall market. But such strength was shown in late May and early June, only to fall back to a support line. It would appear that investors are perhaps ready to begin putting more money in the stock market, thus driving it higher. However, this is not guaranteed. Any negative news item (bad economy, unfavorable government policies, unrest overseas, etc.) could cause investors to hold back, thus allowing the market to fall again.
In this example, the overall market sentiment appears favorable for purchasing stocks, though not strongly so. The trader might use this information to be prepared to enter some long trades (as opposed to short trades), but to manage the trades carefully to avoid a sudden market turn.
Reference: Technical Analysis Explained, 4th Edition, by Martin J. Pring, 2002
David A. Todd - David Todd is a civil engineer, a genealogist, a citizen concerned with the environment, and a writer by passion.
Join the Conversation