Some Basic Market Analysis
In crazy markets like now(Fall 2011) it is helpful to have some basics on understanding overall market direction indicators to help you assess if the market is really showing support after a sell-off or if a market is showing weakness prior to a market top. There is no perfect technical indicator for timing exact market tops and bottoms but there are many indicators proven to help guide you in determining real health of the market despite what TV and media is telling you.
Shorter Term Stock Indicators
Short term indicators are tougher to read because it is emotions not rational thinking that can really drive short term moves causing markets to defy overbought and oversold indicators. Essentially investors are inclined to sell on the news and ask question later in the short term. Although if you have a methodology for reading the market every day or week(depending on your investing style) then you can usually see warning signs before a market makes a big move down. If you get overwhelmed by various indicators then it is always useful to just stick with basic price and volume analysis.
Just watching price and volume can help you alot when determining what is really going on in the market as it is hard for market to continue to move higher without accumulation so many times if you see a market moving higher with low volume and you also see that same thing occurring in the market leading stocks then BE ON ALERT BECAUSE THE RALLY IS PROBABLY NOT SUSTAINABLE. An indicator I like to look for indicator is the market is overbought or oversold in the shorter term are the McClellan Oscillators (Read more about them Here) . The McClellan Oscillators can be used in multiple ways but I just like to look at the free ones provided for the Nasdaq & NYSE in Stockcharts.com to give me a gauge on if the market are overbought or oversold. See the charts below to see what when the readings get really high(+70) or really low (-70) the market is ripe to pull back or move up depending on reading.
Click on Pictures Below to Enlarge
There are other short term indicators like Put/call ratio, market breadth charts(advance/decliners,up/down volume),etc…but I think the McClellan charts helpful are removing some of the noise.
Another short term indicator for evaluating overall market is a chart I wrote about in past post called Heiken chart that I read about in an article. I have been really impressed with the chart for filtering out daily noise and providing some good guidance/system for when to be in and out of the market. You can set up this chart for free in ThinkorSwim papertrade if you don’t have an account there or check to see if you brokerage offers Heiken style charts. I mention how to set up this chart in the past post and how to read it so read that post . I really only just use this chart to look at the S&P500 and havent really used it for other indexes. Below is the current Heiken Chart for the S&P500 (10/5/2011). (Click on chart image to enlarge)
As I mentioned in the past Heiken post you look for when the bars change colors as an intial indicator for potential trend change and then watch to see if the 8day Exponential moving average(Yellow Line) changes direction as a confirming indicator. If 8DMA crosses thru the 21dma(Pink Line) then trend is over/change. If the bars for example turned from green to and 8DMA turns down then have tight stops/be careful. If the 8dma breaks below 21dma then trend is down. If you look at the white arrows I added to the chart you can see how it has performed in this choppy market using the 8dma vs. 21dma crosses in correlation with the bars confirming the move to indicate market direction.
The chart helps you get the main moves in the market an helps to avoid the choppiness like the recent month(Sept 2011). It will also prevent you from being in the market during big meltdowns.
There are hundreds of other short term and intraday indicators but I am not a day trader and I don’t like to overdo it. Just remember almost all indicators use price and volume in their calculation so if you get overwhelmed just learn how to look at volume and price for accumulation and distribution and use rules like those outlined by William Oneil (founder of Investors Business Daily newspaper).
Long Term Market Indicators
Longer term stock market indicators are useful for removing a lot of the short term noise. A popular long term technical indicator is to use a moving average like the 200day moving average on a daily chart or 10 week moving average on a weekly chart. In fact I continue to really like the Mebane Faber method of using the 10month moving average to determine if you want to be in the market or out. He has written white papers about it and is well respected. See my previous post about it and links to the various sites to read about that method. (This would help you avoid major market downturns based on past results). It is a very basic system to follow with little time commitment.
Some people like to reference fundamental indicators like P/E ratio for the market vs. historical P/E but I dont really follow fundamental indicators as the market can remain irrational for a lot longer than a Low or High P/E reading would indicate.
In fact market pundits have continued to emphasis lately that the US market is “Cheap” relative to historical measures but understand that the market is a leading indicator and will reflect the future before the news occurs. In other words if the market is tanking and leading stock are tanking then it might be telling you that fundamentals will weaken and those earnings estimates that make valuations look low might very well go lower causing the valuations to move lower.
Make Sense ? Essentially buy doing fundamental investing you have to decide on if you are think you are more knowledgeable about how much a company is worth than the market is telling you in order to hold onto it. For long term investing with diverse asset classes it can makes sense to average down but it depends on your style and level of comfort with managing your assets.
For long term analysis it is useful to use weekly and monthly charts to indicate long term levels of support of resistance but overall I think it is good to keep is simple with just following a moving average because market tends to eventually revert to the mean.
Overall, technical analysis and chart forecasting is a massive topic that is easy to get overwhelmed with. Overall, it better to catch the main trend than try to pick the exact top of bottom. Don’t try to fight the market and play against the trend. Understand that technical indicators are never perfect but if used correctly they can help to provide discipline to your investing and help to avoid catastrophic losses.