Always try to invest with the trend. Doing so is like rowing a boat down a river. Progress is easy. It is very difficult to progress when rowing against the current. How do you determine what the trend is? If the 200-day average of the market index is rising, then the general trend is up. Does that mean the short seller can’t sell short? It doesn’t mean that at all. We do not define the trend using only one measure. For the person who buys and holds his positions for two years, a long-term rising average is favorable. However, for a swing trader who holds positions from a day to a few weeks, that average is probably irrelevant. That is why the trend indicator must be adjusted to the time horizon (the expected holding period) of the investor.
If you intend to hold your stock for a week or so, then the direction of the 20 day moving average will be important to you. It will be of little or no importance to the individual who intends to hold office for two years. If you intend to hold for a month or more, then the direction of the 50 day moving average will be very important to you. However, there is some overlap here. The direction of the 50 day moving average can also be important to the swing trader. If the swing trader sees both the 20 and 50 day moving averages rising, they will have more confidence than if the 20 day moving average is rising but the 50 day moving average continues to decline. Under the latter condition, you might want to have tighter stops and sell more quickly at the first sign of weakness. If both moving averages are going up, you might be a bit more patient with your positions.
We have said that the trader should trade with the trend, but there is more than one trend to consider. There is the trend of the stock and the trend of the market. Let’s say a person is a relatively long-term swing trader who likes to capture moves that last about a month. It is possible for a stock to have a sharply rising 50-day moving average, while the market index has a falling 50-day moving average. Of course, it’s better if they both move in the same direction as the trade he wants to make. However, there are times when an individual stock will persist in a strong uptrend against the direction of the market. When a downtrend market rallies, stocks with persistent strength will tend to rally as well. When the market has its next drop, the stock in a persistently strong uptrend will tend to decline to its uptrend line. When he reaches that trend line, the smart trader will monitor his behavior. If the stock shows signs of bouncing off that trend line, the trader will buy. By doing so, he is investing with the trend of the stock even if it is against the trend of the market. The fact that the stock is in a persistently strong uptrend is what makes the trade sensitive. Savvy traders often consider a stock’s return to its rapidly rising moving average to be one of their favorite “setup” patterns.
Skilled traders attempt to monitor the general tone or “health” of the market by reviewing a number of indicators. However, there are useful observations that the reader can make without referring to the indicators. For example, if the market goes up on good news, the market is doing well. If it goes down on good news, there probably isn’t a trend in your favor, and bullish reversals carry much more risk. The point is that it is always a good idea to trade with the trend that is right for your investment time horizon. It helps if the market moves in the same direction as the most appropriate trend for your intended stock investment. In other words, if you are a short- to medium-term trader, and the stock you want to trade has a declining 30-day moving average, you should take that as a sign of danger. If the 30-day moving average is rising, that would be a good sign. If the 30-day moving average of the market is also rising, that would be even better.
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