"The Trend is your Friend"
Stock Trend Analysis

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Being able to identify the TREND is the first and most important step of learning Momentum Trading, and therefore how to trade Options profitably. By the end of this page, you should be able to identify whether a stock is inclining up, down, or sideways. Many times, you can eyeball the chart and get the idea, but it does help to have two or three objective measures.

You can do all this in two steps, using four simple indicators. Firstly, you need to identify the general trend of the market and then you find the trend of your chosen stock.

First, find the direction of the general market
Your stock would have to be exceptional to be able to buck the momentum of the market! So, check out the Dow Jones, S&P 500 and the Nasdaq indices. Some stocks are contrarian, such as gold stocks. Often, when the general market dives, the US dollar follows suit, and traders buy precious metals for security. Other than that, most stocks will follow big market moves, either up to down.

I prefer to use the S&P 500 as a measure, because it is most representative of the general market. However, the Dow and Nasdaq also represent important psychological factors in the market direction.

You will need to look at these four indicators:

• The balance of moving averages (e.g. using the 10ma and the 30ma) - shows the trend direction;
• The Wilder's DMI (ADX) - shows the strength of the momentum
• The RSI - shows when a reversal is imminent;
• The Volatility Index (VIX) - shows when a reversal is imminent.

The best place to see these indicators is on Stockcharts, which is a free service. I have set up and bookmarked a template for myself, so that I can quickly view the position of any index or stock. If you join Stockcharts for a nominal monthly fee, you can save your portfolio for quick access to graphs which are updated automatically.

Moving Averages

Set up your graphing service to show the 10 day MA (Moving Average) and the 30 day MA (Moving Average). You could use various combinations of MAs, such as 5 and 20, or 10 and 40, but 10/30 seems a good combination for swing traders. One website recommends using the 10 day MA and the 30 Exponential Moving Average (EMA), which is a much tighter combination, and therefore probably more effective, so I will refer to these from here on out.

• If the 10 ma is ABOVE the 30 ema, then you have an uptrend. This simply means that over the last ten days, the stock has been trading higher than it has been trading on average over the last 30 days, and so is generally heading up. The further apart the trend lines are, the stronger the momentum.
• If the 10 ma is BELOW the 30 ema, then you have a downtrend. This simply means that over the last ten days, the stock has been trading lower than it has been trading on average over the last 30 days, and so is generally heading down. The further apart the trend lines are, the stronger the momentum.
  

Wilder's DMI (ADX) - shows the strength of a trend

• If the ADX is above 30, the momentum is strong, and is likely to continue.
• If the ADX is below 20, the momentum is starting to weaken.
  

Relative Strength Index (RSI) - shows when a reversal is imminent

• If the RSI is above 70, the market is generally thought to be overbought, and an upward trend is likely to turn downward soon. Be careful about entering a trade.
• If the RSI is below 30, the market is generally thought to be oversold, and a downward trend is likely to turn upward soon. Be careful about entering trade.
  

Volatility Index (VIX) - shows when a reversal is imminent (You will need to pull up a separate chart on Stockcharts - enter "$VIX" and have the RSI shown as an indicator)

The VIX is a measure of volatility in the market. Usually, it increases as the market decreases. Its usefulness is in showing when a trend reversal is about to take place.

• If the VIX RSI is above 70, the market has been in a downtrend and is likely to swing into an uptrend. This is confirmed if the VIX is about 10% above its 10 day moving average (ma).
• If the VIX RSI is below 30, the market has been in a downtrend and is likely to swing into an uptrend. This is confirmed if the VIX is about 10% below its 10 day moving average (ma).

Having checked the direction of the general market, you may want to do the same for the Industry of the stock you are interested in. Apply these indicators to an Index that is specific the relevant industry. For example, for gold mining stocks, you may want to use the indicators on the AUX; for semiconductor stocks, you may want to look at the SOX.

Second, find the trend of the your chosen stock

Apply these Moving Averages and the ADX studies to your favourite stock, to get an objective measure of the direction and momentum of your stock. Check the RSI to make sure a change is not in the wind, and look ahead about a month to see whether any earnings dates or dividend announcements are due.

Note: The Moving Averages study is NOT predictive; it lags by about a week, and shows how the momentum changed a few days ago. It merely shows that trend is in place. The RSI is more predictive when it moves into extremes (above 70 or below 30). You can combine these indicators with other stock market predictions techniques that can pin point market turning points often to the exact day and ride the predicted trend afterward to the next minor/ major trend reversal points.

One More Confirmation....
Trend spotting is even easier than falling off a horse. However, there is one service that I can recommend that really does this well. Go to INO.com, and sign up (for FREE!) to their Portfolio service. Enter your list of favourite stocks, and you will receive an e-mail every day about an hour before the market opens. For each stock in your list, you get a momentum analysis with a graph. I have found this incredibly useful.

It really is as easy as that!

Now to Trade....
When you are comfortable with spotting the momentum and direction of your stock, take the next step, and set up a trade to sell a CREDIT SPREAD on your stock.

UPTREND
If your stock is in an uptrend, sell a BULL PUT CREDIT SPREAD.

DOWNTREND
If your stock is a downtrend, sell a BEAR CALL CREDIT SPREAD.

Or: Return from Trend Analysis to the Home Page

Or: Review what you know about Options