A strategy that is often overlooked or just ignored is timing your trades with the trend of the overall market (i.e. S&P 500). After all, if a stock is scheduled to move higher, then it should regardless of third-party influences, right?
Wrong…
From just a statistical approach, when the market goes up 3 out of 4 stocks will go up. When the market goes down, 3 out of 4 stocks will go down. So from this vantage alone it would seem obvious that our best bet to execute profitable trades will take place on up days in the market.
We could break down all the possible reasons why this type of action takes place but pretty much any major news can instantly break any trend, and, depending on various market conditions, traders and institutions will move money to different sectors.
[smartads]
Besides teaching you how to distinguish when a market is going to be up or down (this can be done through simple technical analysis), I want to point out some guidelines I use when determining to enter a position or not.
If you are looking to make quick day trades, then you can virtually play any type of market, but I am not, so the following guidelines are for people not looking for quick day trades.
There are basically 3 guidelines I adhere to, and all are in relation to monitoring the S&P 500.
1. Don’t Buy on Across-the-Board Rally Days
When it looks like all stocks are moving higher and your Google Finance front page is full of green, then do not buy. If anything, sell.
All stocks will looks like buys at this point, so you want to avoid getting duped. Instead, continue to track any stocks that may seem of interest to you.
Probably the worst feeling for any stock trader is accidentally buying a stock at its peak. Sure it might come higher at some point, but how long?
These are the type of market days you want for your current holdings to go through. Ultimately there is no way of timing these rallies, so you want to already be holding onto some positions when they happen.
It is always a good idea to analyze the current standing of those stocks and take profit where needed.
2. Don’t Buy on Subsequent Down Day
While many traders understand the theory behind the first guideline, many more fall into this trap: the market goes up, comes down the next day, and traders instantly see this as a pullback area and start loading up.
Theoretically this sounds nice, but then the next day the market continues to go lower and so on. Now you are trapped in your stock again.
Remember that you always need confirmation. Don’t expect the down day to be just a ‘good opportunity’. We don’t really know if this is just indeed a pullback or the start of a prolonged downtrend, so why take the risk?
3. Buy on the Next Bounce Higher
There are essentially two ways to play the market: predict the future events or react to current actions. In my case, I like to react.
By looking at the chart of the S&P 500, I like to utilize indicators like RSI, spot key resistance and support levels, and determine price action via candlesticks. Once I see a move higher off one of these key tools, I then look at my stocks for possible entry points.
Conclusion
By following these 3 guidelines I can try to prevent myself from falling into traps. These steps can also be carried over into analyzing trends in individual stocks.
To learn more about the technical indicators and skills mentioned in this article, check out my free technical analysis course.