With the Dow back over 10,000, I like a few other people have been considering a taking a few more positions, sticking my neck back out if you will. This got me thinking about the very basic principles of the market. I wanted to share with you a brief list put together by my friend Hale of Bonddad Blog. These are a few basic points that still resonate with him while trading. What do you think, what are some of the basics that you'll never loose? Leave us a comment and be sure to visit Hale at Bonddad blog.
For a guy who lives in the 21st century I have a remarkably old fashioned view of the market. My favorite technical analysts -- Gartley, Murphy, Gann and Schabacker -- are some of the earliest practitioners of the art. There are a few basic points from these people that still stand out for me.
First, you can make money on both sides of the markets – going long and going short. This means we can always be invested so long as we know the market’s direction. To know the market’s direction we need to know how the fundamentals of the US economy are doing – is the economy expanding or contracting? This requires basic knowledge about the economy. If you don’t know it, learn it.
Secondly, what we’re really looking for in the market are reversals or pauses – points when the market changes direction or takes a breather from its current trend. The central idea behind looking for reversals is simple: it allows us to see the beginning of a trend at its earliest point so that we can ride it as long as possible. Remember the old adage “buy low and sell high” (or sell high and buy low if you’re shorting the market)? This is what we’re looking for with reversals. Therefore we need to be familiar with top and bottom formations which according to H.M. Gartley are – head and shoulders, double tops and double bottoms, rounding tops and bottoms, an ascending top or descending bottom, triangles, broadening and “complex.”
Pauses are simply points during a rally where a natural sell-off occurs, but prices don’t break the trend. Ideally we look for a sell-off to a technically important point – for example, some type of moving average, trend line support or Fibonacci level. It’s also important to look for confirmation from a momentum indicator when making this kind of move. For example, has the MACD dipped in an upward trend?
Third, we need to know the market’s three trends – the short, medium and long-term trends. The best measures of these trends are exponential moving averages of the following durations: 10, 20, 50 and 200 days. An exponential moving averages places more emphasis on recent prices, making them better than simple moving averages which assume that all prices in a series are equal. We also need to know the relationship between the averages – specifically, are the shorter moving averages above the longer moving averages in a rising market or are they below the longer averages in a falling market?
Fourth, there are four markets to look at: stocks, bonds, equities and currencies. All of these are inter-related and need to be studied at all times. For example, is a commodity -- like oil -- rising? That means related stocks are probably rising too. Are stocks selling off? That means the treasury market is probably rising because of the safe haven trade. Remember – money will always go to where it can make more money. By watching all of these markets we can see the money flows between the markets.
Finally, remember that the market will make you look like an idiot whenever possible. And the market has more ways to do this then you can count. So always be humble when dealing with the market. Because if you aren’t the market will make you that way in a hurry.