If you’re a swing trader, you're probably familiar with the concept of stock price inertia. It’s the idea that if a stock is moving higher, it’ll continue to move higher into the future, regardless of how short that future may be. It's also the idea that if a stock is moving lower it'll continue to move lower going forward. It’s this one simple idea that a company’s stock price, once in motion, will continue in motion in a continuous direction. And it'll remain in motion along this same path until something makes it change. This idea has a nice ring to it if you think about it out loud. And it seems to make sense, intuitively. It may even provide that feeling of being “scientifically correct” because it's so similar to Isaac Newton’s First Law of Nature from his book "Principia".
“Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.” |
But regardless of how convenient this idea would be for investors, it simply isn't true. None of us can predict the future and there's never been a first law of investing. If there was and the future of stock prices was that easy to predict, we'd all be millionaires by the age of 25 and living on some island somewhere. Instead, stocks are going to behave as stocks have always behaved. They're going to be pushed up and down by buyers and sellers who have a vested interest in the direction of the stock.
"Prediction is very difficult, especially if it’s about the future." |
So why do investors (myself included) believe that prices will continue to move in the same direction they are already moving in (whether that's up, down or sideways)? It's because they believe in the idea that crowds move as crowds. The same way that herds move as herds. It's the idea that once a stock moves in a certain direction investors will notice the move and jump on the bandwagon for the ride (up or down). This is often summed up in the term "the trend is your friend". It's the idea that you are suppose to invest with the trend and then stay with that trend until the trend ends (assuming you can recognize the end of the trend!).
That's harder to do than it sounds. Every stock has a range that it trades in every day and it often trades up and down within that range all day long. It's only when you chronologically separate trading segments that you can truly begin to understand what's happening. It's divide (time) and conquer. For most investors this segmenting is done on a daily basis and the result is a daily chart. Long term investors will segment along weekly lines and this will result in weekly charts. Day traders will segment along several intervals of 60 minutes, 10 minutes, or even one minute to get intraday charts. Once you begin to do this you begin to see patterns.
Some investors will buy and sell securities strictly based upon the action of the stock's price over time. I'm not able to do that because I'm simply not that smart. I have to rely on momentum indicators to confirm or deny my suspicions when looking at the stock's chart and price action.
The momentum indicator I rely on the most is the MACD. The MACD's best attribute is identifying turns in the market (this is very important for swing traders!). When it's below the zero line and beginning to turn up, I take notice because something's about to happen. When it crosses it's signal line, I also take notice. When it crosses from below to above the zero line, I take notice once again.
And when it does the exact opposite of these things, I also take notice.
The other two indicators I like to use are the RSI and the ADX. The ADX tells me the strength of the move that might be under way. It lets me know if the movement up or down has any power behind the move. It therefore lets me know if the move will have any stamina or staying power to it. The RSI, on the other hand, lets me know when the move is getting over heated or nearing exhaustion.
These three indicators combined simply confirm for me what I think I'm already seeing in the movement of the price of the stock. If all three of these indicators tell me the same story then they're giving me the green light to make the trade. If they're incongruent, that tells me something too. It tells me to either look deeper into the fundamentals of the company to understand why, or to move on to another trade.
In the final analysis, the past will provide me with a lot of information but it won't guarantee the future direction of the price of the stock. Stocks will go only where investors push them. My simple intent is to determine if a stock's price is moving up, moving down or going nowhere, to determine if a stock's turning up or turning down, and to determine the strength of the movement. And hopefully, after all is said and done, I'll be on the right side of the trade.
Yogi Berra couldn't have said this any better.
Some investors will buy and sell securities strictly based upon the action of the stock's price over time. I'm not able to do that because I'm simply not that smart. I have to rely on momentum indicators to confirm or deny my suspicions when looking at the stock's chart and price action.
The momentum indicator I rely on the most is the MACD. The MACD's best attribute is identifying turns in the market (this is very important for swing traders!). When it's below the zero line and beginning to turn up, I take notice because something's about to happen. When it crosses it's signal line, I also take notice. When it crosses from below to above the zero line, I take notice once again.
And when it does the exact opposite of these things, I also take notice.
The other two indicators I like to use are the RSI and the ADX. The ADX tells me the strength of the move that might be under way. It lets me know if the movement up or down has any power behind the move. It therefore lets me know if the move will have any stamina or staying power to it. The RSI, on the other hand, lets me know when the move is getting over heated or nearing exhaustion.
These three indicators combined simply confirm for me what I think I'm already seeing in the movement of the price of the stock. If all three of these indicators tell me the same story then they're giving me the green light to make the trade. If they're incongruent, that tells me something too. It tells me to either look deeper into the fundamentals of the company to understand why, or to move on to another trade.
In the final analysis, the past will provide me with a lot of information but it won't guarantee the future direction of the price of the stock. Stocks will go only where investors push them. My simple intent is to determine if a stock's price is moving up, moving down or going nowhere, to determine if a stock's turning up or turning down, and to determine the strength of the movement. And hopefully, after all is said and done, I'll be on the right side of the trade.
Yogi Berra couldn't have said this any better.
"The future ain’t what it use to be." |
Print 
PDF
RSS Feed
