Market Analysis For Traders

Article Overview

In part 1 of this 7 part series I defined 6 critical elements of any successful trading strategy. In case you didn’t read the first article, these key elements are:

A daily routine for analyzing the overall market trend
Details for creating, testing, implementing, and refining screens / other methods of identifying possible trades
Guidelines for opening new trades
Guidelines for monitoring your trades
Open, hold, and closing guidelines
Rules for updating / refining the overall strategy

In this article, I will show you my method of analyzing the the DOW, S&P 500, and NASDAQ markets to identify overall trends. Then following a top down approach, I will break down each sector, and then show you how I track these trends to find stocks gaining momentum in the appropriate trends.

Overall Method

Many of you have heard the phrase “a top down approach” to analyzing the markets. For those of you have not, this means looks at markets from a macro level (overall market) over a longer time period, down to the micro level (individual stock). By applying technical analysis to charts in this fashion, you will better understand which direction the market is heading, and will sharpen your focus when looking to make trades. I do this every Sunday evening in preparation for the week ahead.

Analyzing the Dow Jones Industrial Average

For decades, the Dow Jones 30 (better known as the Industrial Average) has been a barometer of the US economy. Many expert traders start their market analysis with the S&P 500 because it contains a broader range of companies; I choose the Dow because it has history on its’ side.

Step 1 - Choose a Chart Range

When it comes to analyzing markets, I always start with a 5 year monthly chart, then go to a 2 year weekly, then a 1 year daily chart. I use the 5 & 2 year charts for discovering the overall trends and price patterns in the market, and the daily 1 year chart for timing trades within the market.

5 Year, Weekly Chart

I usually only take a quick glance at the five year chart to see if there are any really long term price patterns emerging. Identifying and confirming a pattern and breakout on a 5 year chart is usually a clear indication of long term direction. In many markets, such as google, you can find a very strong trendlines lasting 5 or more years with 5 - 10 points touching the trendline. Trading in the direction of this trendline, or trading breakouts through the trendline can be extremely profitable.

For instance, take a look at the DOW from May 2007, to January 2008. Notice there are several patterns in this chart, but the one I see most prominently is the Head & Shoulders Top which indicated the uptrend was going to reverse and confirmed this pattern at the end of December 2008.

2 Year, Weekly Chart

I use the 2 weekly chart to try and verify the trend or support the pattern found in the 5 year chart. Sometimes you’ll see different patterns in the 2 year than the 1 year.

dow jones weekly chart august 19th 2008
Click To Enlarge

1 Year, Daily Chart

Finally, I take a look at the one year, daily chart. I use this chart for timing the market. Notice that along with price action, I take a look at a couple of different indicators as well (the Aroon, Williams %R, and PPO). There are many reasons why I have chosen to use these 3 indicators, but that is for another article.

Analyzing Sector & Industry Trends

When analyzing stock sectors and industry groups, choosing a Chart Range really depends on your trading style. A good rule of thumb would be to multiple the amount of time you expect to keep your trade open, and multiple it by 4 or 5. Also, there are several groups of sectors you could chose for analysis, however I chose to use the S&P 500 End Of Day sector charts as described on stockcharts.com sector page

I follow the same top down approach for analyzing sectors as I use for analyzing the overall market.

Tracking Sector Trends Over Time

By tracking sector trends over time, you will be able to find pick stocks that are gaining momentum either in the direction of the current trend, or that are very close to breaking out in the opposite direction. The reason for this is that these stocks are receiving attention from institutional investors. This concept is explained in further detail in my articles about sector rotation.