Managing Editor’s Note: As followers of Larry’s expert trading advice, we know you’re aiming to beat the average returns of buy-and-hold investors.
And trading using technical analysis is one great tool to do so.
That’s why, today, we’re featuring a special guest essay from a colleague of ours, Imre Gams, who shares one of his favorite indicators for trading.
So read on to discover one of his top ways to figure out the market’s “mood”…
Trade the market in front of you, not the market you want to see.
This is key if you want to make money over time as a trader.
We all have biases. These are present in every part of our lives – including when we trade.
For example, I’m naturally bearish. I’m always looking over my shoulder waiting for the market to drop.
If I let that bias influence my trades all the time, I would have gone broke a long time ago.
That’s why, as difficult as it is, it’s important to approach trading with as neutral a perspective as possible.
That means using a systematic approach to market analysis.
For me, that means letting a simple rule, not my natural bias, determine if the market is trading bullishly or bearishly.
Today, I’ll show you what that rule is… and how you can apply it to your own trading.
We’ll also look at why this rule means I’m trading stocks bullishly right now.
Figuring Out the Market Mood
To help me figure out the mood of the market, I use something called a simple moving average (SMA).
If you’ve been trading for some time, you’ll know what this is. But if you’re still finding your feet as a trader, let me explain…
The SMA shows the average stock price over a specific period. It smooths out the daily ups and downs to give you a clearer long-term trend.
If the market is trading above its 20- and 50-day SMA, I maintain a bullish stance no matter what.
It’s only when the market breaks below both SMAs that I look to play the downside.
If the market is in between the SMAs or above one but below the other, I take a more neutral approach.
So, where is the market now according to this framework?
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This Market Is Still Bullish
It’s all in the chart below of the blue-chip S&P 500 index.
It tracks the average performance of the largest 500 stocks in the U.S. That makes it a great barometer for the U.S. stock market.
The black line on the chart is the S&P 500. The blue line is the 20-day SMA. And the red line is the 50-day SMA.
As you can see, the S&P 500 is above both these lines.
That means my rules prevent me from loading up on bearish trades.
Until we break below both those SMAs, I’ll be looking to play the upside with my trades.
That means trading stocks that have room to continue going higher.
And I recommend you follow a similar analytical approach… no matter what your gut is telling you to do.
Happy trading,
Imre Gams
Analyst, Market Minute