Knowing where the market is heading is crucial before you decide to buy a stock with a long-term strategy in mind. If the stock of the company you intend to buy shows healthy signs, but the stock market is trending down, then your purchase of the stock may not be a good decision. You don’t want to be in a situation where you are swimming against the tide. In such situation, the price of the stock may be stunted, if not be brought down to some degree. Best way to know where the market is heading is by analyzing it using a stock chart.
My favorite website to read charts is StockCharts.com. Go to the website and under the section “Consistently Popular Charts”, find the symbol $SPX. That is the symbol for S&P 500 Large Cap Index. Click on the symbol, then do the following analysis:
- By visual judgment, the candle sticks should in general get higher in the last few days. May be not all subsequent candle sticks are higher than the previous, but most of them should be higher than the previous day. Eyeballing chart is often not accurate, but at least it can give you a good sense where the market is heading. The following steps should further help your analysis.
- Look at MA(50) (blue line) and MA(200) (red line) indicators. They are the simple moving averages for 50 and 200 days respectively. A favorable condition for a buy would be if a) both MA(50) and MA(200) are heading up, b) MA(50) is higher than MA(200) and c) the index is higher than MA(50).
- Now that the graph shows that the market is likely to head up, there is still one more step to determine if it is a true uptrend or not. Look below the chart where you can add “Indicators”. You are already provided with two indicators. The third indicator that you should add is called Wilder’s DMI (ADX). This indicator allows you to determine if the market is in a trend or in trading range. For long-term investment, we want a trending market. If the indicator’s value is 30 or above, then the market is trending, but it does not tell you which way. Steps 1 & 2 should give you indications of the direction. If ADX is 20 or below, then the market is in trading range; between 20-30, the market is hesitating which course it is taking.
Bear in mind that the above analysis does not mean that the market is definitely going up. Significant changes in the world economy, or any other disastrous event for that matter, may suddenly take the stock market into a dive. But at least the analysis gives some good indication where the market is heading.
An example as taken on 7th September 2010 from StockCharts.com:
The example shows that the candlesticks in the last 5 days are in general moving up, however, MA(50) is below both the index and MA(200). Furthermore, ADX (the black line in the bottom chart), is below 20. That shows the market is in a trending range. With this indication, we shouldn’t make any stock purchase for the time being. Be patient and wait for the right time.
If you are interested in studying further on reading stock charts, I recommend Swing Trading for Dummies by Omar Bassal. Even though this book is not intended for long-term investors, the coverage on reading stock charts and the market in general is quite good. A classic where you can find out more about reading stock charts is Trading For A Living by Dr. Alexander Elder.
Disclaimer: Techniques or analysis covered on this website are to be used at your own risk. I cannot guarantee the outcome of applying any of the techniques or analysis, will always be in your favor. You must always do your own analysis and make your own decision before you purchase a stock.