Market Direction: Predict Or Follow 0 comments

Jan 14, 2010 3:29 PM | about stocks: SPY

A quick look around and you’ll see many people who have an opinion about where the stock market is heading to. Its fun to gaze into your crystal ball and try and pick a number based on some tea leaves and lunar cycles — but is it a smart way of investing?

Of course not.

Will the Williams % or stochastics give you an edge? What about moving averages?

Of course not.

Can using technical or fundamental analysis help put the odds of trading success into your corner?

Charts are interpretive — you can see anything you want to see. Pull up a chart of the S&P 500 (NYSEARCA:SPY ) and you can make the arguement for a continued bullish market, or a market that is primed for a dramatic pullback.

Successful investors don’t predict, they follow.

Since the March 9th bottom, the market has been in an obvious uptrend. Those who have predicted the bull market’s demise have been eating a healthy dose of crow. They will be proven right, but even a broken watch tells the correct time twice a day.

Smart investors follow the trend — which is long, but will use charts to show where clearly defined levels of support are, and limit their risk accordingly.

How do you know when the market direction has changed? There are several ways of doing this, including:

• is the daily share price heading in the same direction for 2 consecutive weeks?
• is the weekly share price heading in the same direction for 4 consecutive weeks?
• has the Advance / Decline number been increasing week over week?
• has the market been putting in a series of higher highs, or lower lows?

Trend followers look to capture 70% of an upmove — not to time the bottom or the top — which is where the majority of unsuccessful traders find themselves going after.

While its great to say you timed the bottom perfectly, or got out at the top, its normally more of a lucky guess than market savvy.

Additionally, successful investors utilize a set of trading rules to put the odds of trading success in their corner. Before they trade, they know the entry and exit points, which are usually, but not always, based on a percentage gain and percentage loss. Smart money management, which includes ensuring you are limiting risk by limiting too much exposure to any one sector, is what seperates a successful investor from the rest.

Charts cannot predict where the market is going, only where it has been. There is a reason why we drive forward and not through the rear view mirrors. Your rear view mirrors serve a specific role, just as technical analysis can serve a specific role in your trading system — they help to tell you a story about where the market has been, not where its going. This can helpful, as a quick glance at a chart can quickly tell you the direction the market trend is heading in.

Remember, its not where you enter, its where you exit.

Leave the predictions to fortune tellers and the talking heads on CNBC — you’re a trader — so follow the trend until it ends.

Disclosure: No positions

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