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Investing

Ideas and Strategies on Investing.

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Watching the DOW

10/3/2013

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 "You cannot teach a man anything; you can only help him to find it within himself."
--Galileo Galilei, Physicist, Mathematician, Astronomer and Philosopher.

  Watching the Dow Jones Industrial Average over the last few months has been a perfect example of using charts to identify patterns. Below is a 4 month chart of the Dow Jones Industrial Average and it clearly shows how the market has gone up and down over this period. Notice how the momentum indicators clearly pointed out when the price became overbought and oversold. In late June and late August the market was bottoming out and in late July and mid September the market was topping out. It now looks like the market is heading south and looking for another bottom. It may or may not coincide with the end of the ongoing government budget dispute but in reality it will end when the market runs out of sellers and buying begins. At that point it is often referred to as a change in sentiment. People suddenly want to buy instead of sell for any number of personal reasons but once the buying starts, greed take over. Once the selling starts, fear takes over. It's the theory of crowd behavior and has been documented and talked about for decades.

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4 Month Chart of the DOW Industrials
  What I hear on television or read in the news on a daily basis is that the market went up or down that day for a reason relevant only to that particular day. And as I've pointed out before, the reasons are given because generally the media has no idea why the market goes up or down but they don't want you to know that they don't know, so they make up something. This is the type of information I tend to disregard first.

  As I turn to the charts I begin to see the ebb and flow of the markets - the periods when it's fashionable to be buying in the market or selling in the market. Once buying or selling starts it seems to continue until the market runs out of buyers or sellers and it starts to level off as the number of buyers and sellers equalize. At that point the market tends to reverses and volume starts to increase as fear or greed begins to set in. 

  In the chart above, the RSI is telling me when fear and greed are getting overdone by moving below the 30 level or moving above the 70 line. The RSI is a great tip-off to the trader that things have moved to an extreme level. A second indicator, the MACD, is telling me several simultaneous things and is my favorite momentum indicator. The MACD Histogram portion provides me with an the early warning signal about the chart's changing directions. The Moving Average crossing the Signal Line portion becomes the first visual confirmation of this directional change. Finally the Moving Average and the Signal Line crossing the zero line is the final confirmation that the stock has reversed direction and is well on it's way. This final confirmation warns me that the trade is well under way and if I'm not in this trade already, I'm already too late to get in. Instead I should start watching the MACD Histogram in anticipation of a subsequent reversal. The third indicator, the ADX at the bottom of the chart, tells me where the pressure is on pricing. The green line reflects buying pressure while the red line reflects selling pressure. By noticing which line is on top I can determine if there is more buying or selling pressure on the stock. The black line doesn't measure buying or selling pressure but instead measures the intensity or fervor of the buying or selling pressure. It helps me understand the amount of "force" that is pushing the stock up or down. And finally, I will, at times, add a Stochastics indicator to the above chart if the market or stock seems to be simply drifting without direction (the Stochastics Indicator is best used in a stagnant market so for me it has a very specialized use). 

  These are the three (four) indicators I tend to use on a fairly consistent basis to support my trading. There are certainly dozens of indicators available for the average trader to use but these are the ones I personally feel give me the most confidence to trade. Every trader needs to understand all of the momentum indicators and oscillators available to them in order to become a better trader. Eventually each and every trader will settle on the ones that work best for them. 
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    I am an Individual Investor with specific interest in long term growth and then enhancing my returns with income from dividends and derivatives. I don't recommend stocks to anyone (it's a good way to lose friends) and no one reading this should misinterpret my blog as a recommendation for any type of investment. I am writing this solely for myself and my kids.


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